Behaviour of stock market prices: information assimilation and market efficiency

Abstract

The stock market plays an important role in the allocation of capital resources. The market is allocation ally efficient when it maintains equivalent rates of return on comparable investments, for this would channelize funds to those users who utilize them most profitably. The pricing of securities is the principal device by which the market allocates capital. Consequently, the efficiency of the pricing mechanism influences the performance of the stock market, in discharging its role as an allocator of funds. In the past few years, there has been a substantial increase in the activities of the Indian stock markets, particularly with respect to the amount of capital raised. During the period April 1980 to March1982, the amount of funds raised from the stock market was of the order of approximately Rs.950 crores. This is in contrast to the sum of Rs.840 crores (approximately) raised during 19704-9. The Government policy also has favored increased mobilization of resources through the stock market. Given the increased level of activity, it is essential to examine the efficiency of the pricing mechanism of the stock market for the absence of the same would render it a poor allocator of resources. According to the theory of efficient markets, stock markets are efficient when prices fully reflect available information. The theory essentially asserts that ‘by acting on publicly available information it is not possible to improve returns beyond the stock market‘s assessment of what is the fair rate of return. The efficiency of the stock market can be of three kind’s viz., (i) weak form of efficiency (ii) semi-strong form efficiency and (iii) strong-form of efficiency. ' The present study attempts an examination of the weak and the semi- strong forms of efficiency of the pricing mechanism in the Bombay Stock Exchange. Further, the study attempts to estimate the stock market's speed of adjustment to information. The period of study is the six year period-starting from January 1976 and ending with December 1981. Two approaches have been used to investigate into the weak form of market efficiency. The first involves testing for statistical independence of successive price changes. The second approach involves the direct testing of different filter rules to determine whether these rates provide profits greater than a buy and hold strategy. The results of the test of the weak form of efficiency indicate that the historical price» series does not offer exploitable opportunities to the investor.

The examination of the semi-strong form of market efficiency was done by analyzing the impact of the announcement of the issue of bonus shares by corporate managements, on the price of equity shares of these companies. Forty bonus issues, declared during the six year period starting January 1976 and ending with December 1981, made up the sample. The Market Model was utilized for isolating the systematic influence on the behavior of security returns. The behavior of the abnormal returns of securities suggests anti- cipation by the market of the declaration of bonus shares. The results indicate that the market tends to corroborate the new information made available with other information at its disposal. The price of the share is determined after taking into account all the available information. The stock market's speed of adjustment to information can be estimated by identify in the beginning and ending times of the adjustment process. Methodology based on the Shewhart control chart theory was employed for ‘Eh s purpose.' The results indicate the existence of two distinct clusters. ..The first cluster includes shares whose adjustment times to new information are short. The second cluster consisted of shares having longer adjustment times. Several implications of the findings of the study have been drawn for the market participants. The limitations of the study and areas of further research have also been indicated.