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The Random Walk Model in the Pakistani Equity market: An Examination

Husain, Fazal (1997): The Random Walk Model in the Pakistani Equity market: An Examination. Published in: The Pakistan Development Review , Vol. 36, No. 3 (1997): pp. 221-240.

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Abstract

This paper examines the validity of the Random Walk Model in the Pakistani equity market. The model, extensively tested in other equity markets, implies that past movements in a stock price are not helpful in predicting future prices of that stock. The model states that changes in stock prices are serially independent and conform to some probability distribution. Conventionally, the independence part is examined through Serial Correlation Test, whereas the distributional aspect is analysed through Frequency Distributions. Same techniques are applied in this paper on daily closing prices of 36 individual stocks, 8 sector indices, and a market index from January 1, 1989 to December 30, 1993. The analysis indicates that the Random Walk Model is not valid in the Pakistani equity market as is the case in other emerging markets. The results show the presence of strong serial dependence in stock returns and indicate the slow adjustment of the market to new information. This points to the weaknesses of the market regarding the dissemination of pertinent information to potential investors, indicating that effective measures should be taken in this regard. The shape of the distribution reveals that stock returns in the Pakistani market, like in other equity markets, do not comply with the normal distribution, implying that theoretical models must be used with caution.

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