Efficiency and Indian Stock Markets

Volatility in Stock Markets

Volatility is the function of uncertainty Reasons
Macro Economy Index Trading High Frequency Trading

Types
Inter-day volatility Intra-day volatility

Market Efficiency
Classification:
Operational Efficiency Allocation Efficiency Informational Efficiency

An efficient market reacts quickly and relatively accurately to new public information, and results in prices that are correct, on average. The Efficient Market Hypothesis is: The theory that markets are efficient and therefore, in its strictest sense, implies that prices accurately reflect all available information at any given time.

Empirical Evidence on Semi-strong Efficiency

Event studies examine stock returns to determine the impact of a particular event on stock prices, in particular, what happens to the stock price, before, during and following the event.

Events include:
Company-specific announcements such as stock splits, takeover announcements, dividend changes, accounting changes. Economy-wide changes such as unexpected interest rate changes

Most event studies have shown that stock prices change before the announcement These results demonstrate that an investor cannot move quickly enough at the time an event occurs (announcement is made) to profit from the change, so this speaks to market efficiency in the semi-strong form,

Empirical Evidence on Semi-strong Efficiency

Efficient (A) and Inefficient Markets (B) and (C)

Stock Price

B A
$23

$20

t
Announcement Date

Time

Empirical Evidence on Semi-strong EMH

Typical Event Study Result for Good News Event
Stock Price

B A
$23

$20

t
Announcement Date

Time

What happened?
The Nifty suddenly dropped by over 900 points to a session low of 4,888.20, a drop of 15.5 per cent below Thursday's closing level in early trade of Friday. Such a sharp drop activated the lower circuit breaker which halted the trade for about 15 minutes on the NSE. Trade on the BSE was normal though the Sensex was also affected by the sharp fall in Nifty prices initially.

Why did the markets fall sharply?

The NSE attributed the sharp drop in cash market to erroneous orders, which resulted in multiple trades at low prices. "The market circuit filter got triggered due to entry of 59 erroneous orders which resulted in multiple trades for an aggregate value of over Rs. 650 crores How long was trade affected? Spot trading was halted on the NSE for 15 minutes from 9.50 a.m. to 10.05 a.m. Trading was not stopped on the BSE.

Who was to blame?

A single dealer terminal at Emkay placed 59 erroneous orders for an institutional client, resulting in trades worth over Rs.650 crore. Emkay, a financial services firm founded 17 years ago, had closed out all the positions from the misplaced trades the firm had been "disabled" from trading Emkay Global shares plunged 10 per cent.

Impact of Freak Trade

Retail investors The stop losses for a lot of intraday calls were triggered, so retail investors who trade daily have suffered losses. A lot of margin calls triggered. Individual stocks All Nifty-50 stocks plunged during the freak trade. For example, Reliance Industries shares plunged 20 per cent to an intra-day low of Rs. 682. However, individual shares also recovered with the Nifty.

 What is SEBI doing?

Ordered a probe into the crash. Examination of safeguard mechanism. Examination of the role of technology in trading. Introduction of a small-duration trading pause Annulment of orders Framework of dynamic trade based price checks to prevent aberrant orders

Literature review
Fama (1991) notes, market efficiency is a continuum. Huiwen Zou (2011) Optimal information efficiency of a stock market can ensure high effectiveness of the stock market Xiqian Zhao, Juan Yang, Lili Zhao and Qing Li the movements of stock market are influenced by the news related with world events in the New York Times. Mitchell and Mulherin point out that the number of Dow Jones announcements has a direct impact on several kinds of securities market activities Tetlock use news articles from the Wall Street Journal to measure the interaction between the media and the stock market.

Research Methodology
The benchmark methodology used to evaluate the reaction of share prices to public announcements is an event study.

Event: Orders by Emkay Global Event date: 5th October 2012, Friday Event window: 5 days Estimation window: Rit = (Pit-Pt-1)/Pt-1 Estimation model: Rt= a + bRMt + Et

Research Methodology
Research Objectives To test the semi-strong efficiency of Indian capital markets. To examine implications of freak trade To understand the risk-management systems in stock markets

Research Methodology
Research Design Exploratory and descriptive in nature to provide insights and understanding. Data Secondary data published by NSE has been used. Time Frame 5th October 2011 5th October 2012 Data Source Data has been collected from the following data sources:
http://www.google.com/finance http://www.nseindia.com

Research Methodology
List of Companies: Total 13
SBI Axis bank Cipla HCL Tata Motors Airtel ITC HDFC Reliance HUL L&T Sesa Goa Infosys

Calculations
Step:1
One year data of closing prices and index values for 13 companies from http://www.google.com/finance Step:2 Calculation of Logarithmic functions for
Market return (X) Securities return (Y)

Step:3 Calculation of Alpha and Beta

Calculations
Step:4 Application of Single Index Model to calculate Normal returns [Rt = a + brmt + ei ] Step:5 Calculation of Abnormal Returns [Actual returns Normal returns]

Analysis

Findings

Conclusion
Flash crashes, nationally and internationally, have been common in the past. From the Black Monday of 1987 to till date where US-based Knight suffered a loss of $440 million after its rogue algorithm caused major disruptions in shares prices of 148 companies on the NYSE. The month of April earlier in the year witnessed drop of Nifty futures over 300 points after stop losses got triggered. The same day shares of Infosys also witnessed a momentary drop of 20%

 This incident has raised doubts over the risk management system and exposed the shallow depth of the country's stock market.

References
http://www.allstocks.com http://usatoday30.usatoday.com/money/perfi /stocks/2011-08-10-volatile-markets_n.htm http://seekingalpha.com/article/580701-arestock-markets-becoming-more-volatile
Introduction to Corporate Finance: Laurence Booth W. Sean Cleary , Chapter 10 Market Efficiency, Prepared by Ken Hartviksen.

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