A Test for Joint Market Efficiency from an Investor’s Perspective

Lakshmi Viswanathan,S Maheswaran,G Balasubramanian

doi:10.4236/tel.2019.95098

Abstract

This paper investigates the cross-country correlation between stock markets and its implications. It does so by introducing a new measure called the Scaled Covariance Difference (SCD), which captures the difference between the covariance of short term returns and longer term returns. This measure has practical implications for portfolio optimization, as well as in testing for the joint efficiency of markets. Our focus in this paper is on including the off-diagonal terms of the variance-covariance matrix in the analysis so as to develop a test for joint market efficiency, unlike the univariate tests for market efficiency which only make use of information along the main diagonal of the variance-covariance matrix. We also demonstrate how to implement the test for joint market efficiency using data on weekly stock returns from the Nifty and S&P 500 indices.

Highlights

Introduction & Literature ReviewStock market efficiency is one of the most fundamental topic of research in finance
It does so by introducing a new measure called the Scaled Covariance Difference (SCD), which captures the difference between the covariance of short term returns and longer term returns
We demonstrate how to implement the test for joint market efficiency using data on weekly stock returns from the Nifty and S&P 500 indices

Summary

Introduction & Literature Review

Stock market efficiency is one of the most fundamental topic of research in finance. In a broad sense, market efficiency depends on the degree to which prices of stocks and other securities reflect all available information in the market. There are a number of subsequent studies which make use of this variance ratio test to test market efficiency. Huang [3], Urritia [4], Smith and Ryoo [5] and Darrat and Zhong [6] tested the efficiency of Asian markets, Latin American markets, European markets and Chinese market respectively using the variance ratio test All these studies analyze one particular market at a time. The above-mentioned studies analyze the variance-covariance matrix to examine the cross-country correlation over time. More importantly we introduce the measure, Scaled Covariance Difference (SCD) to check if there exists any significant difference between 1-week covariance and k-week covariance This measure serves beneficial in portfolio optimization as well as to test the joint efficiency of two markets.

Theory

Analysis

Empirical Findings

Conclusion