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Adaptive Market Hypothesis:
A case on National Stock
Exchange ( NSE)
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Contd
Equity Market:
The market in which shares are issued and traded
through exchanges or O.T.C
NiFTY:
NSE of Indias benchmark index for indian equity
market.
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Introduction
The adaptive market hypothesis, as proposed
by Andrew Lo is an attempt to reconcile
economic theories based on the efficient markethypothesis (which implies that markets are
efficient) with behavioral economics, by applying
the principles of evolution to financial
interactions: competition, adoption and natural
selection.
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Efficient Market Hypothesis
Efficient Market Hypothesis (EMH) states that security
prices fully reflect all available information.
The degree to which stock prices reflect all available,
relevant information.
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Contd
Market Efficiency:
Developed in 1970
Economist Eugene Fama
Stated that it is not possible for an investor to
outperform the market because all available
information is already built into all stock prices
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Forms of EMH
Weak form
Semi strong form
Strong form
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Weak Form
The weak form of EMH states that the current
prices fully reflect the information implied by the
past prices.
In weak-form efficiency, future prices cannot be
predicted.
This form has been designated as the random walkhypothesis (RWH).
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Tests of Weak Form
Serial correlation tests
Runs tests
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Random walk hypothesis
The random walk hypothesis is a financial
theory stating that stock market prices evolveaccording to a random walk and thus the prices
of the stock market cannot be predicted.
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Semi-Strong Form
The semi - strong form of the EMH states that
the current stock prices reflect all publicly
available information and the stock prices
adjust rapidly to new information
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Strong Form
strong-form efficiency, share prices reflect allinformation, public and private, and no one
can earn excess returns
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Objective of the study
To develop an understanding of the variousforms of efficiency of the stock market.
To trace the trend of the movement of the stockmarket index over the study period.
To test whether the Indian Equity markets,especially NSE is weak form efficient or not.
To test whether the Indian Equity markets,especially NSE is semi-strong form efficient or
not.
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Scope of the study
Testing the efficiency of the market is very
important for the investors, stock brokers,
financial institutions, government etc. for
understanding the functioning of the capitalmarkets.
Stock market movement gives an idea to the
investors for buying and selling shares in order toearn some profits
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Tools for Analysis
Runs test
Autocorrelation test Event study
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Runs Test
Non-parametric statistical test
Used to test the hypothesis Based on the null hypothesis
Two elements + and -
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Contd
E(r) = 2n1n2 / (n1+ n+12 )
WhereE(r) = Expected number f runs
n1 = number of positive runs
n2 = number of negative runs
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Contd
S.E = 2n1n2 (2n1n2-n1-n2) / (n1+n2)2 (n1+n2-1)
Where
S.E = Standard Error
The expected number of runs compared with the
actual number of runs.
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Contd
R + 0.5E (r)
Z = -----------------
S.E
Where Z = standardized value
R = Actual numbers of runs
0.5 = Continuity adjustment
E(r) = Expected number f runs S.E = Standard Error
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Contd
The null hypothesis is rejected
if the calculated number of runs falls outside the
95% confidence interval
(-1.96 s = k = + 1.96 s).
The null hypothesis is acceptedif the value lies in between 1.96.
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Rejection Region for Two-Tailed Z Test (H1:
0) with =0.05The decision rule is: Reject H0if Z < -1.960 or if Z > 1.960.
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Serial Correlation tests
The relationship between a given variable and
itself over various time intervals.
serial correlation is used by technical analysts to
determine how well the past price of a security
predicts the future price.
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Event Study
Semi-strong form of efficiency has
been tested by event study.
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Contd
Daily Returns:
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Contd
Security Returns Variability (SRV):
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Contd
Average Security Returns Variability:
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Contd
Average Abnormal Returns:
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Contd
Cumulative Abnormal Returns (CAR):
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Contd
T-Test:
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Analysis
Weak Form
Indices of NSE are efficient
Previous indices value are effectively absorbed bytodays indices
Investors who follow technical analysis will not b able
to earn a return
This indicates that the component stocks efficient
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Contd
Semi-Strong Form
Steps
Collect a sample of firms
Determined the prices
Define the period studied
Compute the daily Returns,
Abnormal return,Average Abnormal return,
Cumulative Abnormal Return
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Contd
Markets are not efficient
Abnormal Returns high Prices have been fluctuated
Fundamental analysis can beat the market
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Conclusion
Based on the result of runs test and auto
correlation test nullhypothesis is rejected.It is proved that Indian equity market follow
random walk modal and is a weak formefficient.
Indian stock market with respect to stock split,
dividend and bonus announcement by
companies using event study and analysis
proves that markets are not efficient in semi-
strong form