Project Report on Testing Random Walk Hypothesis and Study of Surge,
Volatility and Crash at Bombay
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Testing Random Walk Hypothesis & Study of Surge, Volatility and Crash atResearch Proposal on
Testing Random Walk Hypothesis & Study of Surge, Volatility and Crash at
The
bullish and bearish behaviour of financial markets are always in news. Wide
price fluctuations are daily occurrence on the world's stock markets as
investors react to economic, business, and political events. Recently, the
markets have been showing extremely erratic movements, which are in no way as response
to the information that is fed by the markets. Thus chaos prevails in the
markets with investor optimism at unexpected levels. Thus irrational exuberance
has substituted financial prudence. Further, Many economist in the past have
argued on the concept of Efficient
Market Hypothesis with regards to different stock exchanges worldwide globally.
This research will analyse these questions in the context of Bombay Stock
Exchange, India
1.1
Background Information
In
the world of Finance, Fama (1970) developed a theory called Efficient Market
Hypothesis. Fama defines efficient market
in terms of ‘fair game’ where security prices ‘fully reflect’ the
information available. He further explained the concept with its three main
forms i.e. Weak form of market efficiency, Semi Strong form of market
efficiency and Strong form of market efficiency.
In
the Weak form of market efficiency, security prices reflect all past
information about the prices movements. Therefore it will not be possible for
investors to predict future security prices by analysing historical prices. One
of the ways to find whether the capital market is efficient or otherwise is to
find out the correlation between the securities prices over time. Most
empirical tests have shown that there exists serial independence between the
security prices over time. In a efficient capital market, the shares behave
randomly and hence the weak from is referred to as the weak random walk
hypothesis. Alternative method to test weak form is to formulate trading
strategies using the security prices and compare their performance with the
stock market performance. The capital market will be inefficient if the
investor’s trading strategy beat the market. Many researchers have studied a
large number of trading rules and have concluded that it is not possible for
investors to outperform the market. (Pandey, 2006) This paper will test weak
form of efficiency of Bombay Stock Exchange using serial correlation method.
In
the Semi-strong form of market efficiency, the security prices reflect all
publicly available information. This implies that an investor will not be able
to outperform the market by analysing the existing company-related or other
relevant information in, say, the annual accounts or financial dailies.
Researchers in the past have employed event studies to study the semi strong
form of the market efficiency. Event study can be earnings/dividends
announcements, bonus issue, rights issue or change in accounting policies. To
illustrate, a event study can be to study the speed with which the price of
company share is adjusted to this information. (Pandey, 2006)
In
Strong form of efficiency, the security prices reflect all published
information and unpublished, public and private information. This is a strong
assertion, and empirical studies have not borne out the validity of the
efficient market hypothesis in the strong form of efficiency. People with
private or inside information have been able to outperform the market. (Pandey,
2006)
However
market inefficiencies have been found in most researched and regulated stock
markets. This inefficiency exists in the form of Transaction cost, Information
that is not freely available and differences among investors about the
implications of given information. Some of the examples of market
inefficiencies are quarterly earnings, weekend effect and small firm effect.
1.2
Research Title
With
regards to the background information reviewed in detail, a research title is derived
and is named as follows: “Testing Random Walk Hypothesis & Study of
Surge, Volatility and Crash at Bombay
1.3
Aims and Objectives
Aims
The
performance of BSE is also been impressive. Its market capitalization was
$2113.96 in 2000 which rouse to $ 8090.37 billion, a increase by 282.71 % in
the span of 7 years. Its turnover has also increased from $121.40 billion in
2000 to $214.62 billion in 2006. Sensex, the benchmark index of BSE had a
impressive surge from 3315.57 points in January, 1999 to 13884.78 points in
December, 2006. But, at many times, Sensex has encountered shocking intra-day
crash, such as one on 17th May,2004 where Sensex whopped down by 842
points which made thousands of investors loose their investment in matter of couple
of hours. However, the crash were of not long term in nature but had a
tremendous effect on the participants.
Thus
the behaviour of BSE has motivated the author to find whether, if Bombay Stock
Exchange is efficient
Objectives
The
first objective of this research is to examine the literature related to
Efficient Market Hypothesis
Secondly,
to evaluate the performance of Bombay Stock Exchange and to detect recent
developments that leads to create huge crash
Thirdly,
to examine the reasons behind the surge, volatility and crash in share prices
Lastly,
the main objective is to test the efficiency of Bombay Stock Exchange in term
of Random Walkness using Serial Correlation method.
1.4
Research Methodology
Both Qualitative and Quantitative methods have
been used to perform research. Qualitative method is used to review the
performance of BSE and its benchmark index Sensex in terms of market
capitalisation and turnover and number of companies and scrips listed. Further,
it is used to highlight the rationale behind the surge, volatility and crash at
Bombay Stock Exchange. Quantitative method is used to find serial correlation
between monthly returns of Sensex at BSE.
1.5
Chapter Layout of the study
The
chapter layout of this research is as follows:
- Introduction
- Literature
Review
- Research
Methodology
- Case Study
- Findings
and Conclusion
- Bibliography
The
next chapter is Literature Review which will mainly highlight on past studies
done on Efficient Market Hypothesis.
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