Testing Weak-Form Efficiency of Emerging Economies: A Critical Review of literature/Kritine Kylancios Ekonomikos Mazo Rinkos Efektyvumo Literaturos Apzvalga
Nurunnabi, Mohammad, Journal of Business Economics and Management
The concept of EMH came from Fama (1970, 1991) based on the argument of Samuelson (1965) who found that the anticipated price of an asset fluctuate randomly. During the past decades, the efficient market hypothesis (EMH) has been a debatable issue in empirical finance literature because of its significance and implications. The study consists four sections including the introduction. The next section provides an overview of random walk model and its implication on weak-form efficiency test. The section three contains the critical review of literature on weak-form efficiency in developed countries, emerging markets and South Asian perspective. The final section summarizes the conclusions.
"The primary role of the capital market is allocation of ownership of the economy's capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firms' activities under the assumption that security prices at any time "fully reflect" all available information. A market in which prices always "fully reflect" available information is called 'efficient' (Fama 1970: 383)".
Fama (1970) suggested three applicable models of EMH including Fair Game model, the Submartingale model, and the Random Walk model. The EMH can be classified into three forms: weak-form, semi-strong form and strong form (Roberts 1959). Weak-form of efficiency claims that the current share prices reflect all the information that is contained in the historical sequence of prices and technical analysis cannot be used to predict and beat market; Semi Strong-form of efficiency implies that current share prices not only reflect all information content of historical prices but also reflect all the publicly available information; Strong-form of efficiency states that current share prices reflect all information whether it is publicly available or private information (insiders information) (Fama 1970). Later, Malkiel (1992) extended Fama's definition following the two arguments: the security prices would be unaffected by revealing the information and it is impossible to make profit based on the revealed information. Therefore, EMH can be measured by the profits based on the information (Jensen 1978; Campbell et al. 1997; Timmermann, Granger 2004). However, their definitions were based on the information and transaction costs, not involving joint hypothesis (Pesaran 2005).
Nowadays, the concept of EMH in emerging market is becoming more important because of the globalization, free movement of investments across national boundaries and the huge capital inflows from developed economies. Traditionally, the markets of developed economies are more efficient compare to emerging markets (Gupta 2006). The fundamental reason is that the development of capital markets is lower which which results in less regulations and control in the weak markets (Gupta 2006). Among the emerging countries in South Asia, the capital markets of Bangladesh are enormously growing very vastly, however not like India, but in an impressive way (See Table 1).
At this stage, it is useful to assess the level of efficiency in Bangladeshi stock market. However, very few research focus on the Bangladesh and they are dated and inconclusive. The empirical research found that emerging markets are not efficient in semi-strong form or strong form. So, it is justifiable to review the weak-form studies rather than semi-strong form or strong form. Wong and Kwong (1984) suggest that if the evidence fails to support weak-form efficiency, it is unnecessary to test the semi-strong form or strong form efficiency at the stricter levels. There are other reasons which might be affected to test the semi-strong form or strong form efficiency in emerging economies, including the unavailability of sufficient data, structural profile, inadequate regulations, lack of supervision, companies' information circulation before the officially availability of annual reports, dramatic movement of the markets and the rumours of information (Worthington, Higgs 2003). …