Abstract
This paper has investigated the Efficient Market Hypothesis (EMH) through the concept of lead-lag relationship of the future market prices and spot market prices in the context of Pakistani stock market. The study has used data of randomly selected one hundred and forty firms listed on the Karachi stock exchange from January 1995 to March 2012. Spot and future indexes have been developed from the closing prices through the Price-Weighted index method. First stationarity of the data has been checked through AugmentedDicky Fuller test then GARCH (1,1) model has estimated for both the spot and future index returns in order to investigates the volatility in either of the index. The results of GARCH (1, 1) suggested that the impact of the previous day volatility in both the spot and future index has impact on the current day volatility. The future market price volatility has more prominent value to explain the spot market prices as compared to that of the explanatory power of the future market prices based on the spot market prices. Therefore it has concluded based on the GARCH (1,1) there exists lead-lag relationship between the future and spot index and future market leads the spot market. Granger casualty test has used to triangulate the results of GARCH (1,1) model. The results showed that future market Granger causes the spot market while the spot market does not Granger causes the future market. Thus it can be concluded that it is the future market prices that lead the spot market prices and thus there exist a Lead-Lag relationship between the future and spot market prices in Karachi stock exchange and one can predict changes spot market price based on the changes in the future market price. Moreover, these empirical results support the view that it’s the future market where information has created about the security prices and then it disseminate to the spot market. This study shall help the investors in the establishment of the investments strategies for Pakistani stock markets.
Highlights
The weak form of the efficient market hypothesis in the spot and future markets have gotten sufficient attention from the research students, academics and practitioners due to the market volatility and arbitrage opportunity available with the investors to outperform the market
In order to investigat the impact of the future price volatility on the spot prices Generalized Autoregressive Conditional Heteroskedasticity (GARCH) (1,1) has been estimated as shown in the table 4.4. the empirical results suggested that spot market volatility can be explained by the volatility in the future market but the explanatory power of the spot market volatility to explain the future market volatility has greater than the former one
The results suggested that future market prices Granger causes the spot market prices based on the F-value 7.071 and its P-value 0.0003 which is greater than the critical value and Null hypothesis is rejected while the alternate hypothesis is accepted and future prices Granger Causes the spot prices
Summary
The weak form of the efficient market hypothesis in the spot and future markets have gotten sufficient attention from the research students, academics and practitioners due to the market volatility and arbitrage opportunity available with the investors to outperform the market. The concept of the price lead- lag relationship of the future index with the underlying spot index is that how quickly one market incorporates the newly arrived information as compared to other, and how much the two markets are associated with each other. A good number of researches investigated the significant lead-lag relationship of the futures index and underlying spot market (Finnerty and Park (1987); Kawaller, Koch, and Koch (1987); Harris (1989); Stoll and Whaley (1990)). Booth et al(1999), suggested that price discovery has the process through which the new information incorporated in the securities prices that would lead the share prices to attain equilibrium It has been verified in different studies that derivatives market enclosed good or bad news information and later on the same information reflected in the stock price. The fifth section represents the conclusion and future scope of the study
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