Academic journal article IUP Journal of Applied Economics

Market Reaction to Listing of Stocks on F&O Segment of NSE: Application of Event Study Methodology

Academic journal article IUP Journal of Applied Economics

Market Reaction to Listing of Stocks on F&O Segment of NSE: Application of Event Study Methodology

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Any typical event study involves the estimation of the effect of an event on the wealth of the shareholders, and hence measurement of abnormal returns during the event period is central to the event study. There has been considerable empirical evidence which emphasizes that successive price changes in individual common stocks are very nearly independent. Studies by Alexander (1961), Fama (1965) and Samuelson (1965) supported the random movements in stock prices. Empirical research till 1969 mainly aimed at assessing the market efficiency by observing the independence of successive price changes. There has hardly been any study which examined the speed of adjustment of price to specific event or news or information. Fama et al. (1969) is the first event study which introduced a conventional methodology for testing the behavior of stock returns surrounding the stock split.

An event study assesses the impact of an event on corporate valuations. Researcher is concerned with how the corporate events like dividend payments, stock splits, bonus issues, merger or acquisitions, announcement of corporate earnings, etc. can have an impact on the value of the firm, i.e., how the impact will be reflected in the stock or other security price performance. Unusual behavior in stock price performance at the time of event reflecting either abnormally positive or negative performance is inconsistent with market efficiency. Event studies act not only as a tool to test market efficiency, but also to assess the impact of policy decisions. Event study methodology can be applied to both firm-specific and economywide events.

Cox (1976) studied the impact of introduction of futures trading in organized exchanges on the spot market for six different commodities (onions, potatoes, pork bellies, hogs, cattle, and frozen concentrated orange juice) being traded on Chicago and New York exchanges, usin g effic ie nt market model. He compared the price behavior of these commodities during pre-futures period with that of post-futures period and observed that futures trading increases the size of the information available to the traders and in turn improves the spot market efficiency. There was no evidence of futures trading imposing cost on the producers and consumers, which was contrary to the argument that futures would have negative price effects on the underlying assets and hence to be prohibited. Instead, it improves market efficiency of the spot market due to the free flow of information.

The relationship between price and information applied by Cox (1976) is in line with the efficient market explanation by Fama (1970), i.e., prices in an efficient market fully reflect all available information. Estimated price at time t (Pt), conditional upon the set of information available at time t - 1 is an unbiased estimate of Pt. E[Pt - E(Pt/all information at t - 1)] = 0. Hence, Efficient Market Hypothesis (EMH) believes that subsequent price changes are independently and identically distributed random variables indicating that stock price changes are random.

Event study is a joint test of the measuring abnormal returns and of testing the validity of the model used to measure normal returns. The difference between actual/realized returns and normal returns is considered as abnormal returns which is attributable to the effects of the event. Normal return is the return expected in the absence of the event. There are various models to measure normal returns like constant mean return model, market model, Capital Asset Pricing Model (CAPM), Arbitrage Pricing Theory (APT), etc. The use of CAPM and APT almost came to an end since the 1990s due to the validity of the assumptions behind the models. Brown and Warner (1985) conducted large-scale simulations and found market model to be superior to constant mean return model as it removes the portion of the return attributable to variation in the market's return, thereby reducing the variation in abnormal returns. …

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