MARKET EFFICIENCY AND EFFECT OF STOCK EXCHANGE PRICES (What is market efficiency and how it relates with stock

market prices, either the markets are efficient or not) ABSTRACT

Surveys of market efficiency mainly focused on testing informational efficiency. Counter markets, the corporate and government bond markets, the option market, and the market for seats on the New York Stock Exchange. Investors behaviors, transaction costs and trading restriction also effect upon market efficiency because they reflect the tests of market efficiency. Fama (1991) focuses mainly on informational efficiency of security prices.

LITERATURE REVIEW
For testing that either market that we are going to study is efficient or inefficient has some tests from which we are able to analyze about the level of market. Allan Clive W.J. Granger describes that the efficient market hypothesis provide a platform that helps in forecasting market efficiency in given information. There are several market efficiency tests that rely on establishing profitable trading opportunities in real time. Forecasters constantly search for predictable patterns and affect prices when they attempt to exploit trading opportunities. A closely related definition of market efficiency is provided by Malkiel (1992) that is A capital market is said to be efficient if it fully and correctly reflects all relevant information in determining security prices A capital market is said to be efficient with respect to corporate event announcement (stock split, buyback, right issue, bonus announcement, merger & acquisition, dividend etc) contained information and its disseminations. How quickly and correctly the security prices reflect these event contained information show the efficiency of stock markets (J. Clement Sudhahar) the prices are weak form of efficiency known as random walk theory in which the current stock prices reflect all the information that is contained in the historical sequence of prices, semi strong form of efficiency in which information is publicly available about the companies being studied and strong form of efficiency in which current market prices reflect all information whether it is publicly available or private information (insiders information).
Another definition is given by Jensen (1978) defines market efficiency as follows: A market is efficient with respect to information set xt if it is impossible to make economic profits by trading on the basis of information set xt. Information availability affects upon prices that makes economic profits by trading on the basis of information. Three points are emphasized in these definitions, namely (i) the importance of the information set adopted in the test, xt ; (ii) the ability to exploit this information in a trading strategy; and finally (iii) that the standard for testing if the EMH holds is measured in economic profits. A market is efficient with respect to the market information system if, for all market signals, the price and asset allocation are identical to the price and allocation that would arise in an artificial economy with the same configuration of preferences and endowments but where each trader's signal is the original market signal. 1

Efficient prices are equivalent to the prices in an artificial economy where all traders receive the market signal.

The efficient market hypothesis (EMH) is a backbreaker for forecasters it forecasts the returns from speculative assets that is the basis for random walk theory (Bachelier, 1964). EMH is difficult to test that needs considerable care. In EMH Market participants behavior really matters that predicts returns and profits by the stock market. Everyone with a new prediction method wants to try it out on returns from a speculative asset, such as stock market prices, rather than series that are known to be forecast able. The EMH is special in that investors current and future forecasts of payoffs affect their current and future trades which in turn affect returns. Efficient market hypothesis is one of the important pillars of financial economics; traders normally behave rational and also expect rationally Fama (1970). Traders may survive in the long run and use their impact on price dynamics De long el (1991). Irrational traders can persistently maintain their long lasting influence or their relative wealth becomes quite small enough Kogan (2006). Surreys of market efficiency mainly focused on testing informational efficiency. The empirical evidence is largely supportive of weak form and semi-strong form efficiency Fama (1970). Different methods are used to check the impact of information on stock market prices like CAPM model. Investors behaviors, transaction costs and trading restriction also effect upon market efficiency because they reflect the tests of market efficiency. Fama (1991) focuses mainly on informational efficiency of security prices. Many researchers had done a lot of work on market efficiency such as Mackinly (1988), all find out evidence of certainty and productivity in financial market is concerned it is typically high unpredictability and enhances collapses but dont stops. This fact cannot properly explained by changes in fundamentals. It is supposed that price limits may provide cooling off periods for traders and re- examine the intrinsic value of assets kahneman (1994). Unpredictability is reduced. According to the theoretical point of view consequences may show different aspects based on different hypothesis or fame work (Brennan, 1986).in addition such database normally effect from different hypothesis about rationality that the researcher assume to characterize the market traders Beaver (1968) examined the reaction of the Trading Volume Activity (TVA) and Security Returns Variability (SRV) to annual earnings announcement with a sample of 143 New York Stock Exchange (NYSE) firms. The result indicated 33 percentage increases in TVA and 61 percent increase in SRV in earnings announcement week over the non-announcement weeks. A study by George E. (1970) found that the random walk hypothesis implies that the price movements are virtually independent of past price movement. That shows that the random walk hypothesis may be incorrect or, at least incomplete. Miller (1979) in his study argues that any non-random fluctuation in price (other than a steady upward drift approximating the risk adjusted rate of returns) would be exploited by speculators who would buy before an expected fall, eliminating any predictable functions and making all price changes random.

Market efficiency includes some long term anomalies that are chance results, apparent overreaction of stock prices to information is about as common as under reaction. Most important, the long-term return anomalies are weak. They tend to disappear with reasonable changes in the way they are measured (DeBondt and Elsevier Science (1985)).Event studies, introduced by Fama, produce useful evidence on how stock prices respond to information. Exploring the usefulness of price limits based on empirical data also pretense great difficulties. First it may go through from econometrics Chou (1997). Second rationality from the point of view of market phenomenon is not necessarily consistent with that at the bottom i-e traders rationality. Goud and sounder (1993) find that market rationality could result from individuals irrationality. Third empirically discriminating between information hypothesis and overreaction hypothesis would be problematic, with neither understanding what is happening in the traders mind, not being able to predict what had happened had the price limits not beet imposed. Simon (1957) argues that bounded rationality is more acceptable concept for describing human behavior. Besides, financial data usually exhibits several stylized facts such as volatility clustering and fat tails for the return series as well as volume persistence of which the causes can not be well explained by traditional asset pricing models. Kirma (2006) points out that heterogeneity are necessary part of evolutionary systems. Heterogeneous and varying expectations may account for many stylized facts. Many heterogeneous models have been proposed to generate rich and complicated market dynamics. The advantages of varied agent model of financial market are addressed in Hamoes (2006) and Lebarrn (2006), who also provide an extensive review of this research data. Hamoes (2006) pays more attention to stylized version where there exist only few different types of traders. Lebarrn (2006) largely discuss the model with much different type of traders where theoretical results are difficult to derive. The goal of this paper is to present artificial agent based financial market to examine the success of price limit the best work in this area is done by Westerhoff (2003) who projected chartist basic list model, was firs to identify the success of price limits based on agent based modeling mechanism. The price limits can minimize unpredictability and make price less distorted, While the price distortion increases if price limits are too restrictive such results are recently been conformed by Westerhoff. However numerous designs look like to be unsuitable in general environment. Like many other agent based models which includes Chiarelley and Hommes (1998 assuming that traders rely on trading rules of pre-specific forms may limit the traders capability to process information , perhaps result in unfair ending. To stay away from such disapproval we suggest an artificial stoke market model which is directly related to he framework of Brock and hommes (1998) and Santa Fe Artificial stock market (SF-ASM) of Authur (1997) and LeBaron (1999). The modeling techniques use expectations d for traders expectations ad market mechanism, are however different. Capital formation in market depends upon its efficiency and efficiency of financial institutions. the capital market is efficient with respect to information regarding corporate event announcement that how quickly and correctly security prices reflect these information about event announcement that is anyone like stock split ,buyback ,bonus announcement ,right issue,
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dividend, merger &acquisition etc show that market is efficient. likewise we can see in Indian stock market with respect to bonus issue announcement by it companies and we see that bonus issue announcement by IT companies contains informations that are useful for valuing the securities and this has checked by different methods like ASRV that is average security return variability and other thing is that capital market for IT companies stock show their reactions heavily on the day of any event announcement and on the next day of announcement however reaction on 1st day is greater that the next day. Before announcement came up and day -5 to -1 the security prices significantly affected and this bonus announcement information is useful for valuing the securities. The market reacts quickly during post announcement period for bonus announcement and the reaction was extended up to 15 days for bonus announcement by IT companies. So through short selling technique investors can make abnormal returns by using the information of bonus announcement. The technique of cumulative average abnormal return for bonus announcement also shows that market immediately reacted to information of bonus announcement. The efficient market hypothesis has been widely tested and it seems consistent in wide variety of markets that is in new York and American stock exchanges and the Australian English and German stock markets, various commodity future markets the Over-theCounter markets, the corporate and government bond markets, the option market, and the market for seats on the New York Stock Exchange. The basic purpose is to bring together a anomalous evidence regarding market efficiency. Various tests conducted to test market efficiency like the test of joint hypothesis and test can fail because either the one or two hypothesis are false and there is an evidence to study recent criticism of asset pricing model so the eventual resolution of these anomalies helps in more precise and more general theories of market efficiency models of equilibrium to determine the asset prices under uncertainty. Efficient market hypothesis is an important concept and in finance accounting and economics of uncertainty. The efficient market hypothesis is accepted as a fact of life its three broad categories have developed is the weak form of efficient market hypothesis and semi strong form and the strong form of efficient market hypothesis. In the survey paper anomalies in relationship between securities and examines the evidence to stock price reaction to earnings announcement and the post announcement risk adjusted abnormal returns are systematically non zero in time period that following earnings announcement in a fashion that is inconsistent with market efficiency and non zero abnormal returns are due to inadequacies in two parameter assts pricing model and also explicit test to determine whether those abnormal returns are due to market inefficiency or from deficiencies in asset pricing model and the results concludes that abnormal returns are due to market inefficiency not from deficiency of asset pricing model but in later study Thompson is unable to distinguish on the basis of evidence and the evidence of stock split study shows some indications of non-zero abnormal returns and Charest evidence on market price adjustment to stock splits is generally consistent with market efficiency but Charest is unable to determine the exact cause of abnormal returns.

MENA Markets
Countries in MENA markets
Lets see the informational efficiency in the MENA stock markets. The MENA (Middle Eastern and South African) includes Egypt, Morocco, Tunisia, Jordan, Lebanon, Israel, and Turkey. From the research point of view MENA markets have remained untouched. 7 MENA markets have been analyzed by constructing an efficiency index using 20 statistical tests that includes random walk tests, technical trade analysis and ordered logit analysis as well.

Less Developed Markets

MENA markets are perceived as less developed as compared to other markets. Egypt, Turkey and Israel are most developed markets as compared to other market in the MENA markets. 7 countries have been selected as sample in the study. The standard empirical testing includes a number of approaches such as the existing of the predictability of the using past information of the price, checking if trading rules could be used as for the profit making.

Analyzing the MENA markets

A number of analyses used describe the trend towards the market efficiency of the MENA markets. Unit Root Analysis suggests the support for the random walk hypothesis and provides support for the rejection of the random walk hypothesis for the MENA markets. Individual variance ratio analysis provides good finite sample properties and being sensitive to serial correlation (Lo and MacKinlay, 1989). Random walk hypothesis requires variance ratios in all the intervals. The null hypothesis of random walk is rejected in Egypt, morocco and Lebanon in this case. From the technical trading rules the resultant rules find out some of the unseen patterns that are not recognized by the linear models. A total of 35 rules have been analyzed for 7 MENA markets. The main objective of the efficiency index is to rank the MENA markets according to their efficiency. Weak-form market efficiency is strongly reflected in Turkey and Israel where as other countries are still behind.

Reforms introduced by the Italian market

Let us have a look at the reforms introduced by the Italian stock market and their effect on the market efficiency. The efficiency is evaluated through the use of traditional information efficiency model and microstructure approach.

Approaches for analyzing the market

Traditional informational efficiency model is defined as It tests the market efficiency by verifying the predictability of prices conditional on some informational subset. A

Microstructure approach is defined as that measures the efficiency as the distance of the price movement from their efficient components, represented by a random walk process.

Underdeveloped Market
As compared to the other leading countries industries Italian market is underdeveloped. This inefficiency is due to some of the factors such as inefficient design of trade mechanisms, insufficient demand of structure and share issues in a firm.

Factors Influencing Market Efficiency

The reform in the Italian stock exchange has influenced a number of factors at various level of the market efficiency such as its size expansion, increasing completeness, modernizing trading and settlement system. The relation between the price and volume has been linked up with the traditional analysis and the microstructure approach. Two different data sets have been used on the prices and returns, one with the daily data and second with the intraday data. The daily data analysis took into consideration the prices and the trading volume of securities. These were usually taken from the period they were listed.

Market Efficiency after Reforms Introduced

From the results it can be derived that in the daily level for the least and most liquid shares, there is improvement in the market efficiency for the most liquid shares and no improvement has been found in the least liquid shares. But as we look at the intraday data there is a significant difference in the results. There is no improvement in most liquid shares as well as least liquid shares as well from the intraday data point of view. The analysis shows strong positive correlation between the changes in prices and the volume of the trade. Trading volume information content is different from the other so the reform in the stock market weakens the relationship only in the case of liquid securities. Moreover the prices of the illiquid shares are of poor quality as compared to active trade securities.

THE ANALYSIS OF MARKET EFFICIENCY

Market efficiency analyzed beyond the cost standards and the dimensions of cost including opportunity cost, the timing and incidence of expenditures and the special cost of market activity associated with communication and risk reduction. The paper written by lee and Norman, proposes some specific criteria that might be adopted for appraising the efficiency of market activities, and it uses data drawn from simulation experiments to examine some indicators of market performance with respect to these criteria.

It is concluded from this analysis that extending criteria for appraising market efficiency, both within the firm and in a larger systemic context, beyond the cost standard is both feasible and necessary, and that specifying and measuring a range of appropriate efficiency criteria is a major task of marketing research.

CRITERIA OF MARKET EFFICIENCY

Market efficiency in economic literature has been equated with market outcomes generated by perfect competition. There are some tests of exchange efficiency with primary reference to agricultural markets that are suggested by different researchers that without attempting direct empirical application market efficiency can be tested. Four more specific indicators of market efficiency are identified by the researchers (1) viability-stability, (2) Ratio of units traded to marketing effort, 3) Revenues of market participants and (4) Realization of potential transactions.

Viability-stability is the first market characteristic examined by Balderston and Hogget in their analysis of the simulation model, and is the first consideration cited by Stigler-"The basic function a market serves is to bring buyers and sellers together." The importance of stability follows directly from the association between in-stability and risk, and between risk and cost. A market is efficient when cost changes are readily reflected in price changes, demand changes reflected in volume changes, and random instability not associated with fundamental readjustments is at a minimum. Number of Units Traded and Amount of Market Effort The definition of efficiency in terms of physical output per unit of input has been widely adopted in economic analysis. Revenues of Market Participants It has been suggested by Balderston that one criterion
of the efficiency of marketing organization may be the maximization of total net revenues of all market participants other than final buyers.

Realization of Potential Transactions in centralized and decentralized market the

realization of all potential transactions between buyers and sellers, unless there are artificial barriers to entry and take bid and offer prices. As a result, there is no "market price," but only some central tendency or aver-age of actual prices. Single criteria or indicators of market efficiency thus appear unacceptable, and the task of appraising proposed efficiency increasing changes in marketing organization or practices is more complicated than may have been supposed.

What affects the efficiency of market?

Efficient market is unobservable. In an efficient market must therefore be modeled, and the test of market unlike naturally occurring markets, the efficiency of a laboratory efficiency. Traders'
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information signals perfectly identify the value of the risky asset. Previous experimental research in market efficiency has used markets with aggregate certainty. Under uncertainty disappear when the information in the market collectively traders have different information signals, the presence of aggregate uncertainty significantly reduces efficiency relative to similar markets with aggregate certainty. Signal and other traders are uninformed. In these markets there are traders. Thus, diversity of informed traders' information and aggregate the study also manipulates the number of traders in the market. The results show within a trading period, however, markets than do markets with many traders. In any investigation of a market's efficiency, different traders must otherwise the market is efficient by definition. Information signals to different traders. The markets presented here give good news signals and other traders received bad news signals. In the number-of-traders treatment, some traders receive a signal while other traders do not. Other traders receive the information via third class mail. The term "efficiency" is frequently used in another context. In the financial economics literature, an allocation is Pareto efficient if there is no existence other allocations that dominate the given allocation, where each trader's welfare index is the expected utility of final wealth, given his or her beliefs (see Ohlson 1987, 49). A well-known example of a market that generates Pareto efficient allocations is one with a complete set of state contingent claims (or Arrow-Debreu securities). Unfortunately, a market that is information ally efficient need not generate Pareto efficient allocations. Informational efficiency means only that the equilibrium is as if all traders have the common market information system, but homogeneous information systems alone do not assure Pareto efficient allocations different information systems; all public and private information (resulting in strong form efficiency), all public information (resulting in semi strongform efficiency), and past prices (resulting in weak-form efficiency). However, if accounting disclosures generate of markets in which traders have different information systems. When assessing between strong-form efficiency and semi strong-form efficiency appropriately differentiates the previous empirical literature systems because these systems are largely unobservable. Experimenter explicitly specifies each trader's information system. This study has considered how different features of a market affect its price and allocation efficiency. Based on the comparison between the AU and N12 markets, I would expect markets with an information structure of informed and uninformed traders to be more efficient than markets with all traders are informed but different traders have different information. Large firms also have considerably more volume than small firms.

Exchange Rate Market Efficiency: Across and Within Countries

To test for exchange rate market efficiency across countries, a number of researchers are there to test the Exchange rate efficiency that can also be tested within a single country by testing for comovement between a single countrys spot and forward exchange rates. This study investigates the efficiency of the spot and forward exchange rates markets. To test for market efficiency across countries, forward exchange rates across countries are determined efficiently in the market. The pairings of the spot and forward exchange rates, overall, the findings support market efficiency across countries among the spot and forward exchange rates of the G-7 countries for the period 19731996.

One of the anomaly is the Monday effect in daily stock returns which shows that Monday returns are negative or low that the other days. Eastern European Emerging Markets have been considered under study because they have been neglected from this point of view. 11 EEEMs have been taken under consideration. Among the 11 markets the empirical analysis showed that there were negative returns in the six EEEMs in which two markets namely Estonia and Lithuania had major negative returns. In the remaining five markets positive stock returns were observed but Russia had major positive returns among them. This shows that there is no presence of Monday return anomaly in the EEEMs markets. Absence of Monday effect recommended that regardless of of speculation these market exhibit the inefficiency at their early stage of development. But there is always some level of efficiency that exists in these markets. The African stock markets have been increasing with a fast pace but they lack operational efficiency and they are mostly segmented due to which they are representing themselves as illiquid and small. Weak form efficiency has been the main focus in the study of these African markets. The 24 African country wide stock price indices returns are less non-normally distributed than any of the eight individual stock price indices. The most of the African stock market prices indices are weak form efficient against the Wrights Rank (2000) and sign test where as none of the individual national indices are efficient against ranks and signs. If African stock market integrate their operations well there will be improvement in liquidity and efficient allocation of capital. Listing rules must be coordinated. Efficiency will definitely improve with the better integration of the national stock exchanges. Concluding it can be derived that the weak form informational efficiency is extensively better continent wide as compared to the national wide.

Electronic Trading
After more than two decades the manual trading system was converted in to the computerized system of trading mechanism. The basic purpose of new system is to provide investors more security and simplicity. This paper will check the efficiency of Amman stock exchange (AME). Computerized system should attract more investors, improve trading volume and liquidity and improve the price detection process (Domowitz 1993, Pirrong 19996). The augmented market efficiency progresses the aggregation and transmission of information through price signals, thus allows agents to make more informed investment decisions and extend their risk more effectively (Amihud et at). In broader sense, efficient stock prices give ways and offer the benchmark against which cost of capital for and return on investment from projects can be reviewed, even if such projects are not financed during the stock market (green et al. 2000). Risk taker investors will require high risk premium, which boost cost of capital and diminish market liquidity (Kim and Signal 2000). According to that point of view liquidity and stock market efficiency depends upon the rules of governing, handling, and execution of trade. In other words these rules do not change; efficiency is not expected to change (Massimb and Phalps 1994).

Many researchers explored that the impact of electronic trading on market efficiency is developed in many countries; (Anderson). The pricing efficiency is measured by using rescaled range analysis before and after automation on the New York stock exchange (NYSE) and Tel Aviv Stock Exchange (TASE). Researchers investigated the impact of electronic trading on the pricing efficiency of the Landon and Australian stock exchanges by using smooth-transition correction models (Taylor et al)

Weak for of market efficiency:

The performance of stock is measured from the weak form of market. The findings of experimental testing of market error efficiency hypothesis (random walk), the early studies are done with stock price has been mixed. Early studies by Fama (1965), Samuelson (1965), could not reject random walk. The early refusal of random walk was founded by (Niederhoffer and Osborne (1966). Poterba and summers (1988), they argued that there is a little academic basis for strong affection to the null hypothesis that stock price follow a random walk. The stock market returns of emerging countries are highly predictable and have small association with stock return of developed countries (Harvey 19993). He concludes that rising markets are less efficient than developed markets and that higher return and low risk can be obtained by including rising markets stocks in investors portfolios, although some studies ( Balaban, 1995) supported (Harvey 19993). Declaration about non randomness of emerging markets stock prices, some other studies related to these same markets (Butler & Malaikah) do not. The weak form of market efficiency for the ISE composite index over 1998-1994 using both parametric is tested (simple ordinary least square) and non parametric random walk tests Balaban. The results shows that the ISE stock market is nor weak and neither semi strong form of market efficiency and the weak form of market efficiency of the Greek stock market and concluded that the efficient market hypothesis (EMH) cannot be rejected Panas (1990). While making indirect inference about time variation in expected stock returns by comparing unconditional sample variances to estimates of expected conditional variances and the evidence reveals more predictability as more information is used and it shows that small changes in expected returns can produce large and economically significant changes in asset values and it presents new estimates of time variation in expected returns of stocks using indirect method. Weak form test in which weak form information is used find no reliable evidence of predictability in modern data. Semi strong form test find small but economically significant predictability and there is no evidence that predictability has diminished in recent years. While analyzing market efficiency in shanghai stock market overtime that was constructed on November 26th 1990 and was put into operation on December 19th in the same year that led to the establishment of Chinese stock market. We saw that price limited reform greatly improves the degree of efficiency in long term but influence was very slight in short term. After the reform the range of daily price variations would be at most 10% and some special treated stocks would be at most 5%. The Chinese stock market is basically old driven market. If an order price were 10% higher or lower than the closing price of previous business day then order would be ineffective and transaction cannot be accomplished. This price limit concept hampers the possible transactions to certain extent which is intuitionally in contradiction with free market and limit is very important in controlling the speculative bubble. Before the reform the stock prices
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changed very fiercely with their range with sometimes even reaching 100% in a day. The market could easily operated by some institutional investors. After the reform the change of market index became more moderate. So its very necessary for us to analyze the influences on market efficiency by reform and the evolution of market efficiency during its history. Market efficiency is a subtle concept that is hard to test empirically. Under the environment of financial crisis great influence will be on market efficiency but in fact there is not very essential effects of financial crisis on shanghai stock market but however we cannot come to conclusion that shanghai stock market is efficient now. The reasons of minor influence were that Chinese capital market has not been opened completely and asset securitizations are still in initial stage now. The phenomenon of continuously large fluctuations within several days still always appears that implying the correlation and shows that shanghai stock market is not efficient in short term now but the persistence of fluctuations also shows that shanghai stock market is not efficient in long term as well. When evaluating two Indian stock markets (Bombay stock exchange), (Indian national exchange) for checking its efficiency and for their diversification benefit that they offer to international investors. After applying tests the conclusion was that both Indian stock markets are strongly integrated into international markets and therefore diversification benefits that offered to international investors is minimal or even questionable. I have also seen that most of the Indian stocks have strong dependence on international stock market, while there may be possibility of diversification benefits through small number of stocks. The diversification benefits that offered by Indian stock market are limited to global portfolios. In terms of predictability of Indian stock returns, Indian markets have strong and causal dependence on international equity markets so it may be possible to predict the Indian stock returns based on the returns of other markets so it will be clear that Indian stock markets are strongly integrated with international markets. So the efficiency of Indian stock markets is questionable because returns may be predictable based on international market returns and however also seen that Indian national exchange seems to be more efficient and less internationally integrated as compared to Bombay stock exchange.

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