Abstract
In this research I investigate persistence in monthly excess stock returns over risk free rates in two South Asian stock markets i.e. S&P CNX 500 and KSE 100 stock price indexes using non-Gaussian state space or unobservable component model with stable distributions and volatility persistence. Results from non-Gaussian state space models show that both markets encompass volatility persistence. KSE 100 has a stable characteristic exponent of 1.748, but for S&P CNX 500 index the value for the characteristic exponent is 1.999 which shows normal behavior in this market. Both markets encompass persistent signal in returns at 10% level of significance. The efficiently estimated excess returns for S&P CNX 500 are 0.01% per month (0.12% per annum), and 0.015% per month (0.18% per annum) for KSE 100 index.
Highlights
Fama (1991) shows that predictability in stock returns have been explored extensively in the literature
There is ample difference in two markets that can be characterized by low values of characteristic exponent, the volatility persistence parameter, and high values of leverage parameter in KSE 100 index compared to S&P CNX 500
The study results indicate that even after accounting for GARCH-like behavior, the excess returns are significantly non-normal
Summary
Fama (1991) shows that predictability in stock returns have been explored extensively in the literature. Akgiray and Booth (1986), Jensen (1991), de Vries (1991), Buckel (1995), Mantegna and Stanley (1995), and McCulloch (1997) found evidence of non-normality in stock returns. Conard and Kaul (1988) employed state space or unobservable component model to predict stock returns considering that shocks in both the observation and state Equations are normal. I investigate possible existence of persistent predictable signal in monthly S&P CNX 500 and KSE 100 indexes excess returns over the respective risk free rates. In order to account for non-Gaussian data, I model returns within the framework of Parisian stable distributions that were employed by Mantangna and Stanley (1995), Buckel (1995), and McCulloch (1997).
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