Testing Weak Form Market Efficiency for Emerging Economies: A Nonlinear Approach

Omay, Nazli C. and Karadagli, Ece C. (2010): Testing Weak Form Market Efficiency for Emerging Economies: A Nonlinear Approach.

Abstract

In this paper, we address weak form stock market efficiency of Emerging Economies, by testing whether the price series of these markets contain unit root. Nonlinear behavior of stock prices is well documented in the literature, and thus linear unit root tests may not be appropriate in this case. For this purpose, we employ the nonlinear unit root test procedure recently developed by Kapetanios et al. (2003) and nonlinear panel unit root test Ucar and Omay (2009) that has a better power than standard unit root tests when series under consideration are characterized by a slower speed of mean reversion. Large power gains are achieved through combining cross-sectional information and nonlinear estimation techniques in computing unit root tests. The results of ADF and PP indicate that Bulgarian, Greek, Hungarian, Polish, Romanian, Russian, Slovenian and Turkish stock markets are weak form efficient, while the results of nonlinear unit root test implies that Russian, Romanian and Polish stock markets are not weak form efficient. Moreover, the linear panel unit root test suggest that this group as all efficient where as nonlinear panel unit root test suggest as a group they are not efficient.

• Item Type: MPRA Paper
• Language: English
• Keywords: Keywords: Linear and Nonlinear Unit root and Panel Unit Root, Emerging Markets, Market Efficiency
• Subjects: G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C12 - Hypothesis Testing: General; C - Mathematical and Quantitative Methods > C0 - General > C01 - Econometrics

References

Aguirre, M. S., and Saidi, R. (1998) Evidence of forward discount determinants and volatility behvior, Journal of Economic Studies, 25, pp. 538-552.

Azad, A.S.M. S. and Bashar, H.M.N. O. (2010) Market efficiency and mean-reversion in developing stock markets: Evidence from South Asia, SSRN Working Paper Series No: 1541803

Bajaj, M. and Vijh, A. (1990) Dividend clienteles and the information content of dividend changes, Journal of Financial Economics, 26, pp. 193-219

Bajaj, M. and Vijh, A. (1995) Trading behaviour and the unbiasedness of the market reaction to divided announcements, Journal of Finance, 50, pp. 255-279

Bamber, L. (1987) Unexpected earnings, firm size, and trading volume around quarterly earnings announcements, The Accounting Review, 62, pp. 510-532

Beechey, M., Gruen, D. Vickery, J. (2000) The efficient market hypothesis: a survey, Reserve Bank of Australia, Research Discussion Paper No: 2000-01

Brigham, E. F. and Gapenski, C. G. (1994) Financial Management: Theory and Practice. The Dryden Press, U.S.A.

Brigham, E. F. (1995) Fundamentals of Financial Management. The Dryden Press, U.S.A.

Brock, W.A. and Hommes, C.H. (1998) Heterogeneous beliefs and routes to chaos in a simple asset pricing model, Journal of Economic Dynamics and Control, 22, pp. 1235-74.

Cajueiro, D.O. and Tabak, B.M. (2006) Testing for predictability in equity returns for European transition markets, Economic Systems, 30, pp. 56-78

Chaudhuri, K. and Wu, Y. (2003) “Random walk versus breaking trend in stock prices: evidence from emerging markets”, Journal of Banking and Finance, 27, pp. 575–92.

Copeland, T. (1979) Liquidity changes following stock splits, Journal of Finance, 34, pp. 115-141.

Courtault, J. M., Bru, B., Crepel, P., Lebon, I. and Le Marchand, A. (2000) Louis Bachelier on the centenary of Theorie de la Speculation, Mathematical Finance, 10, pp. 341-353.

Cowles, A. (1933) Can stock market forecasters forecast?, Econometrica, 1, pp. 309-324.

Cowles, A. and Jones, H. (1937) Some a posteriori probabilities in stock market action, Econometrica, 5, pp. 280-294.

Cowles, A. (1944) Stock market forecasting, Econometrica, 12, pp. 206-214.

Dickey, D. A. and Fuller, W. A. (1981) Likelihood ratio statistics for autoregressive time series with a unit root, Econometrica, 49, pp. 1057–72.

Dockery, E. and Vergari, F. (1997) Testing the random walk hypothesis: evidence for the Budapest stock exchange, Applied Economics Letters, 4, pp. 627-29.

Dumas, B. (1992) Dynamic equilibrium and the real exchange rate in a spatially separated world, Review of Financial Studies, 5, pp. 153–180.

Emerson, R., Hall, S.G. and Zalewska-Mitura, A. (1997) Evolving market efficiency with an application to some Bulgarian shares, Economics of Planning, 30, pp. 75–90.

Fama, E. F. (1970) Efficient capital markets: a review and empirical work, Journal of Finance, 25, pp. 383-417.

Fama, E. F. (1991) Efficient capital markets: II, Journal of Finance, 46, pp. 1575- 617.

Francis, J. C. (1991) Investments: Analysis and Management. McGraw-Hill Inc., Singapore.

Franses, P.H. and van Dijk, D. (2000) Non-Linear Time Series Models in Empirical Finance, Cambridge University Press.

French K. and Roll, R. (1986) Stock return variances: The arrival of information and the reactions of traders, Journal of Financial Economics, 17, pp. 5-26.

Gallagher, L. and Taylor, M.P. (2001) Risky Arbitrage, Limits of Arbitrage and Nonlinear Adjustment in the Dividend-Price Ratio, Economic Inquiry, 39, pp. 524-36.

Grieb, T. A. and Reyes, M. G. (1999) Random walk tests for Latin American equity indexes and individual firms, Journal of Financial Research, 22, pp. 371–83.

Harrison B. and Paton, D. (2004) Transition, the evolution of stock market efficiency and entry into EU: The case of Romania, Economics of Planning, 37, pp. 203-23.

Hasanov, M. ve T. Omay, (2008) “Non-linearities in Emerging Stock Markets: Evidence from Europe’s Two Largest Emerging Markets,” Applied Economics, 40(23), 2645-2658.

Holthausen, R., Leftwich, R. and Mayers, D. (1987)The effect of large block transactions on security prices: A cross-sectional analysis, Journal of Financial Economics, 19, pp. 237-267.

Hong, H. and Stein, J.C. (1999) A unified theory of underreaction, momentum trading, and overreaction in asset markets, Journal of Finance, 54, pp. 2143–84.

Kapetanios, G., Shin, Y. and Snell, A. (2003), Testing for a unit root in the nonlinear STAR framework, Journal of Econometrics, 112, pp. 359-79.

Kim, O. and Verrecchia, R. (1991a) Trading volume and price reactions to public announcements, Journal of Accounting Research, 29, pp. 302-321.

Kim, O. and Verrecchia, R. (1991b) Market reaction to anticipated announcements, Journal of Financial Economics, 30, pp. 273-309.

Kraus, A., and Stoll, H. (1972) Price impacts of block trading on the New York Stock Exchange, Journal of Finance, 27, pp. 569-588.

Lakonishok, J. and Vermaelen, T. (1990) Anomalous price behavior around repurchase tender offers, Journal of Finance, 45, pp. 455-478.

Liu, X., Song, H. and Romilly, P. (1997) Are Chinese stock markets efficient? A cointegration and causality analysis, Applied Economics Letters, 4, pp. 511–5.

Lo, A.W. and MacKinlay, A. C. (1988) Stock market prices do not follow random walks: evidence from a simple specification test, Review of Financial Studies, 1, pp. 41- 66.

Luukkonen, R., Saikkonen, P. and Teräsvirta, T. (1988) Testing linearity against smooth transition autoregressive models, Biometrika, 75, pp. 491-99.

Magnusson, M. A., and Wydick, B. (2002) How efficient are Africa’s emerging stock markets?, The Journal of Development Studies, 38, pp. 141-156.

Malkiel, B. G., (2003) The efficient market hypothesis and its critics, CEPS Working Paper No: 91.

Michael, P., Nobay, R.A., and Peel, D.A. (1997) Transaction costs and nonlinear adjustment in real exchange rates: an empirical investigation, Journal of Political Economy, 105, pp. 862-79.

Mishra, P. K. (2009) Indian capital market – Revisiting market efficiency, Indian Journal of Capital Markets, 2 , pp. 30-34.

Mussavian, M. and Dimson, E. (1998) A brief history of market efficiency, European Financial Management, 4, pp. 91-103.

Omay, T. and Kan E. Ö. (2010) “Re-examining the threshold effects in the inflation–growth nexus with cross-sectionally dependent non-linear panel: Evidence from six industrialized economies.” Economic Modelling, 27(5).

Phillips P.C.B. and Perron, P. (1988) Testing for unit root in time series regression, Biometrica, 75, pp. 335-46.

Rockinger, M. and Urga, G. (2001) A time varying parameter model to test for predictability and integration in stock markets of transition economies, Journal of Business & Economic Statistics, 19, pp. 73-84.

Ross, S. A., Westerfield, R. W., and Jordan, B. D. (2001) Essentials of Corporate Finance. McGraw-Hill Inc., U.S.A.

Sarno, L. (2000) Real exchange rate behaviour in high inflation countries: empirical evidence from Turkey, 1980-1997, Applied Economics Letters, 7, pages 285-91.

Sharpe, W. F., Alexander, G. J., and Bailey, J. V. (1999) Investments. Prentice Hall, U.S.A.

Shleifer, A. (2000) Inefficient Markets. An Introduction to Behavioural Finance. Clarendon Lectures in Economics, Oxford University Press, Oxford.

Seiler, M. J. and Rom, W. (1997) A historical analysis of market efficiency: Do historical returns follow a random walk, Journal of Financial And Strategic Decisions, 10, pp. 49-57.

Taylor, M.P., Peel, D.A., Sarno, L. (2001) Nonlinear mean-reversion in real exchange rates: towards a solution to the purchasing power parity puzzles, International Economic Review, 42, pp. 1015–42.

Teräsvirta, T. (1994) Specification, estimation, and evaluation of smooth transition autoregressive models, Journal of the American Statistical Association, 89, pp. 208-18.

Uçar N. and T. Omay, (2010) “Testing for Unit Root in Non-linear Heterogeneous Panels,” Economics Letters,104(1),pp.5-8.

Zalewska-Mitura, A. and Hall, S.G. (1999) Examining the first stages of market performance: a test for evolving market efficiency, Economics Letters, 64, pp. 1-12.