Testing the dynamics in the irregular fluctuations in the stock price changes of Indian stock market

Inhaltsverzeichnis

1. Introduction

2. Review of Literature/Theatrical Background of the Study

3. Research Methodology and Research Hypothesis
3.1 The Random walk Hypothesis
3.2 Small-shuffle surrogate method
3.3 Variance ratio test

4. Data and computational details

5. Empirical Results

6. Limitation of the study and future research

7. Conclusion

References

List of Tables

1. Descriptive Statistics of Stock Returns

List of Figures

1. Time plots for returns and prices data series for all the indices

2. Plot for AC and AMI of log of prices for all indices. The solid line is the original data and dotted lines are the small-shuffle surrogate data

3. Plot for AC and AMI of log differenced prices for all indices. The solid line is the original data and dotted lines are the small-shuffle surrogate data

4. Plot for variance ratios with 95% confidence band for all indices. The solid line represents the variance ratio and dashed and dotted lines represent upper and lower 95% confidence band respectively

ABSTRACT

Stock price changes generally fluctuate stochastically. The purpose of this paper is to investigate whether the stochastic fluctuations in the stock price changes are random or have some kind of dynamics in the context of Indian stock market using a recently developed method, a small shuffle surrogate method, on daily data of six indices of National Stock Exchange of India Ltd (S&P CNX Nifty, CNX 100, S&P CNX 500, CNX Nifty Junior, CNX Midcap, CNX Smallcap). The study of dynamics in irregular fluctuations of asset price changes has implications related to risk management, asset allocation and trading strategies. A small shuffle surrogate method does not depend on any specific data distribution. Our findings support the presence of dynamics in the stock price changes of S&P CNX 500, CNX Nifty Junior, CNX Midcap and CNX Smallcap. On the other hand, price changes in S&P CNX Nifty and CNX 100 exhibit random behaviour. To test the robustness of the results, we also compute the variance ratio of the stock price changes over different asset holding periods. The result from the variance ratio test also supports the findings of small-shuffle surrogate analysis for all indices.

Keywords : Market efficiency, Small-shuffle surrogate method, Irregular fluctuations, Financial data,

1. Introduction

Stock price data shows irregular fluctuation, so it is important to investigate whether such irregular fluctuations in stock price changes are random or it has some kind of dynamics. Testing random behavior of financial time series helps in answering whether financial asset prices are predictable or not. This forms the base for testing weak form efficiency i.e. inability to forecast the asset prices using historical prices in the financial markets (Fama (1970)). The analysis of random walk in asset prices is important for practitioner as its presence can impact the implications related to risk management, portfolio selection and trading strategies. For financial market professionals, a correct assessment of the market is important to implement optimal investment and trading strategies. The foundation of literature of random walk hypothesis lies in the ground-breaking works of Bachelier (1900), Cootner (1964), Samuelson (1965) and Fama (1970).The basic assumption in testing random walk hypothesis (RWH) is the increments in asset prices to be IID (identically and independently distributed). If random walk hypothesis holds, then asset returns are non-predictable and market participants cannot make abnormal returns over their holding periods. The methods that test the IID disturbances are restrictive in nature. Testing random behavior of stock price changes has a long history. Earlier studies (pre – 1980) to test random walk hypothesis were inspired by the theories related to movements in the financial markets to the business cycle. Samuelson (1965) document that in efficient markets, price changes must be unpredictable which supports the statistical evidences provided by Kendall (1953), Cowles (1960), Osborne (1959 & 1962). The post – 1980 studies are inspired by the ground-breaking studies of Poterba and Summers (1988), Fama and French (1988) and Lo and MacKinlay (1988).

The central aim of this paper is to investigate whether the irregular fluctuations in the stock price changes in the stock indices from Indian stock market are random or have some kind of dynamics. This paper attempts to answer a question: Is Indian stock market efficient and fair game? This paper uses a recently developed method, the small shuffle surrogate method (Nakamura and Small, 2005) to test the null hypothesis that price changes are independently distributed. We also make use of Lo and MacKinlay’s (1988) variance ratio test to confirm the findings obtained by small-shuffle surrogate method.

The remainder of this paper is organized as follows: Section 2 discusses the literature review on the issue. Section 3 introduces the methodology used in this study. Section 4 discusses the data and computational details. Section 5 reports the empirical results. Section 6 highlights the limitation of the study and future research and section 7 concludes with summary and main findings.

[...]