Abstract
This study explores stock market efficiency in India after allowing for potential structural changes induced by reforms processes and/or external shocks. The endogenous determination of structural break dates, using mostly Clemente, Montanes, & Reyes (1998) (CMR) methodology, allows us to identify important events in this respect. External shocks such as occasional stock market scams, policy and political regime changes, oil price shocks and the effect of global market meltdowns have caused abrupt or one time changes in the series mean (additive outlier model), while the reforms processes stand out to be the single most important cause for the gradual shifts in the level of stock indices (innovation outlier model). This underlines the importance of institution building and the domestic policy stance in countering external shocks.
Highlights
The structure of the Indian stock market has undergone a sea change since the early 1990s
The efficient market hypothesis (EMH) provides a theoretical basis for empirically testing for the degree of success in achieving market efficiency, whereby finding evidence in favour of market efficiency is equivalent to testing some form of the random walk hypothesis for the relevant stock prices
An external shock can impact either as an additive outlier in which a single point in the series is affected causing a sudden change in its mean or as an innovative outlier where an innovation to the process affects both an observation and the subsequent series causing a gradual shift in the mean
Summary
The structure of the Indian stock market has undergone a sea change since the early 1990s. The opening up of financial markets led to heightened cross-border flow of capital with India emerging as an investment destination, resulting in the Indian stock market taking cues from and being impacted by global events. Integration and capital flows have made room for adoption of international best practices for the Indian market increasing its efficiency. In this backdrop, the present paper is an attempt to verify whether stock prices in India do follow a random walk or are mean-reverting in nature
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