The Efficient Market Hypothesis and the Thinly Traded Kuala Lumpur Stock Exchange: Tests with Appropriate Refinements

Studies on the Efficient Market Hypothesis (EMH) in both the developed and developing capital markets have revealed mixed evidence. EMH presupposes an ability to detect incorrectly priced securities and profitable arbitraging opportunities which move the market towards efficiency. The early empirical work on developed securities markets purported to provide evidence that securities market prices are unbiased in their reaction to relevant information. This means that investors cannot consistently profit from any delays in price adjustment reflecting new information. However, evidence from subsequent studies, in the early 1980s, have not reached such cons is tent conclusion. These studies show anomalous price behaviour in securities markets: among others, size effects, turn of the year effects, week- end effects, etc., which are argued by some as evidence of market inefficiencies. The Kuala Lumpur Stock Exchange (KLSE) being small and illiquid provides a suitable setting to evaluate the EMH in a thinly traded scenario . In prior studies on market efficiency of the KLSE, no attempt was made to control for market thinness. In order to control for market thinness, ten portfolio deciles of KLSE listed stocks which differ in the degree of market thinness were created. The standardised volume of trading was proxied as a suitable indicator for measuring market thinness. Three tests were performed to evaluate the weak- form efficiency of the KLSE : (i) Q - statistic which measures the average serial correlations, (ii) individual serial correlations analysis (for 12 lags) and (iii) unit roots analysis. Test results on six equally-weighted dividend-distributed industry sector portfolios, two existing indices (namely the KLSE Composite Index and the New Straits Times (NST) Industrial Index) and an equally - weighted market ·portfolio (Rmt ) indicate that the KLSE Composite, the NST Indus trial and the two industry sec tors (hotel and tin sectors) exhibit average serial correlations cons is tent with weak- form efficiency. Results on the ten portfolios which differ on the degree of market thinness showed that all except three exhibit average serial correlations consistent with weak-form efficiency. For individual serial correlation results, 90 percent of the 30 component stocks of the NST Indus trial Index showed price behaviour consistent with random walk or weak- form efficiency. A unit root test was applied using a sample of stocks from each of the ten portfolio deciles. The Dickey-Fuller test of significance suggested that current prices are the best estimates of future prices. An average of 87 percent of the current price behaviour is explained by the immediate price lag variable. To evaluate the semi- strong form efficiency, an infrequently traded sample (Sample One) and a frequently traded sample (Sample Two) of annual earnings and dividend changes were used to study price react ions to information arrival. Three methods were used to estimate the residual returns: the market adjusted returns, the risk-adjusted returns and the risk-adjusted returns incorporating the Dimson, Fowler and Rorke (DFR) corrections for thin trading bias

Is the KLSE efficient? Efficient market hypothesis vs behavioral finance

Over the last 100years since Bachelier (1900)pioneering work on Random Walk Hypothesis, studies on the Efficient Market Hypothesis (EMH) have revealed mixed evidence. EMH states that stock prices reflect information. In an efficient market the prices of stocks reflect a rational assessment of the underlying worth of stocks. On average you will make money but the money you make is just enough to cover the risk you have assumed. If markets are efficient then new information is reflected quickly into market prices. Conversely, if markets are inefficient, information is reflected only slowly into market prices, if at all. EMH also presupposes an ability to detect incorrectly priced securities and profitable arbitraging opportunities which move the market towards efficiency. After the first marginal investor had profited from a price increase (or decrease), subsequent investors with the same information obtain no significant profits. This means that, in general, majority of investors cannot consistently profit from any delays in price adjustment reflecting new information. However continuous stream of well-documented evidence from the behavioural finance literature suggest that markets are inefficient. This paper attempts to review this controversy based on world evidence at large and with special reference to the Kuala Lumpur Stock Exchange and offers suitable panacea to rationalize this phenomena

Price Changes and Trading Volume Relationship: Some Preliminary Evidence from the Kuala Lumpur Stock Exchange

This study provides evidence regarding the relationship between price changes and volume of trading of firms listed on the KLSE. Absolute price changes were found to have a strong relationship with trading volume compared to price changes. Transaction volume associated with a price upturn was, on the average, larger than the transaction volume associated with a price downturn which probably explained the positive correlation between price changes and trading volume. Causality tests indicated that price changes cause volume changes but not vice versa. The interaction test showed that large transaction volume coupled with an increasing trend in price will further gather momentum and result in a further increase in price. This fll1ding, however, does not suggest that the KLSE is weak-form inefficient which provides an opportunity to investors to devise strategies as there is evidence that the KLSE is weak-form efficient and pockets of inefficiencies observed are not economically viable. The findings defy the basic tenet of technical analysis that past price volume data can be consistently used to design profitable investment strategies

Shareholders' versus management's interest: A review

Shareholders are basically owners of their corporations who elect corporate directors (who are policy makers) and employed corporate management (who implement corporate policies). In modern businesses, due to the large number and dispersion of shareholders, control is normally vested to professional managers who may pursue actions in their own self-interest rather than those of the shareholders. This paper reviews various ways managers are perceived to deviate from the shareholders' wealth maximisation objective, and the possible methods and constraints involved of aligning management's and shareholders'interest

The Performance and Signalling Process of Initial Public Offers in Malaysia: 1980-1996

Malaysian IPOs are, on average, substantially underpriced compared to underpricing in other emerging and developed market. The findings of this study suggest that this average abnormal return on the first trading day is 135 percent, after which the returns decline slightly in the first week and gradually increase thereafter. A test on possible signalling attributes of new issues to potential investors reveal that of all the suggested determinants, the ex-ante risk factor seems to explain the level of underpricing

Returns to Bidding and Target Finns in Hostile Takeovers: Some UK Evidence

This paper explores the returns to bidding and target firms in hostile takeovers and their combined wealth effects on the announcement of the offer in the UK. The findings reveal that bidder firms earn negative and significant abnormal returns, whereas target firms earn positive and significant abnormal returns. The gains to target firms more than compensate the losses suffered lry bidders as the combined gains are positive and significant. These findings are consistent with those documented in the US. The positive and significant combined gains imply that takeovers are wealth-creating investments, which is consistent with the notion that managers pursue takeovers to maximise wealth rather than size of theirfirm

The Stability and Predictability of Betas: Evidence from the Kuala Lumpur Stock Exchange

Beta measures the systematic or undiversifiable risk of a security. Investors desire stable (and hence predictable) measures of beta to enable them to accurately estimate the expected returns on their investment. Instable betas lead to inaccurate estimates of expected returns over time and hence provide misleading signals on performance of investments. This study examines the stability and predictability of the three leads/lags version of FowlerRorke betas (unlike OLS betas, these betas address the problem of thinness of trading peculiar to the KLSE) of 148 firms listed on the Kuala Lumpur Stock Exchange (KLSE). The findings suggest that the beta of both individual securities and portfolios are quite stationary over time. As expected the portfolio betas are relatively more stable than individual securities betas. Furthermore, the method of portfolio formation affects the relative portfolio beta stability. However, portfolio beta stability is achieved with 15 or more securities, irrespective of method of portfolio formation. Overall, the findings indicate that investors can reliably utilize estimated individual security and portfolio betas for their portfolio selection and investment decisions

Factors Associated with Stock Price Volatility and Evaluation of Gordon's Share Valuation Model on the Kuala Lumpur Stock Exchange

The worldwide increase in share price volatility in recent years has stimulated an abundance of research in an effort to understand individual share price volatility in international markets. The objectives of this study are: (i) to isolate factors suggested by investment theories and practices and to observe their ability to jointly explain share price volatility on the developing Kuala Lumpur Stock Exchange (KLSE) and (ii) to evaluate the applicability of Gordon's share valuation model on the KLSE. The findings suggest that five of the six suggested variables jointly explain 23 per cent of price changes on the KLSE for the period 1975 to 1990, and two of these factors were significant at 5 per cent level. Gordon's model holds well with F-statistics significant at 5 per cent level, R-squared is 70 per cent, and the signs of the coefficient of dividend and earnings growth variables are in the predicted direction. Contrary to popular belief, fundamental factors appear to be a significant force influencing share price changes on the KLSE

The Dividend and Earnings Behaviour of Firms on the Kuala Lumpur Stock Exchange

The dividend and earnings behaviour of firms in developed economies are well documented. In Malaysia, there is hardly any published evidence on these issues. This study investigates the dividend and earnings behaviour of firms listed on the Kuala Lumpur Stock Exchange (KLSE). The findings suggest that: (i) the dividend decisions of these firms partially depend on their current earnings and past dividends; (ii) firms have long-term target dividend which is conditioned upon their earnings ability, and (iii) earnings changes of firms are random which implies that earnings forecasts by analysts might be of no economic significance

Country governance and the performance of Islamic and conventional banks: international evidence

The impact of corporate governance on banking firms has been widely documented in the literature. Noticeably absent is an extensive examination of the impact of country governance on the efficiency of banking firms. This limitation is surprising, given the fact that the banking sector remains the most important channel for savings and allocations of credit in the economy. By using data on 454 Islamic and conventional banks from 19 countries offering Islamic banking and finance products and services, this chapter attempts to fill this demanding gap. We find that voice and accountability positively influence the efficiency of both Islamic and conventional banks. On the other hand, we observe the negative impact of political stability, absence of violence and control of corruption. The findings indicate that government effectiveness, regulatory quality and rule of law negatively influence the efficiency of conventional banks, but not so in the case of Islamic banks