A Test for Joint Market Efficiency from an Investor’s Perspective
- 1 Institute for Financial Management and Research, Chennai, India
- 2 Institute for Financial Management and Research, Chennai, India
- 3 Institute for Financial Management and Research, Chennai, India
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.
- Bachelier, L. (1900) Théorie de la spéculation. Annales scientifiques de l’école Normale Supérieure, 17, 21-86. https://doi.org/10.24033/asens.476
- Lo, A.W. and MacKinlay, A.C. (1988) Stock Market Prices Do Not Follow Random Walks: Evidence from a Simple Specification Test. Review of Financial Studies, 1, 41-66. https://doi.org/10.1093/rfs/1.1.41
- Huang, B.N. (1995) Do Asian Stock Market Prices Follow Random Walks? Evidence from the Variance Ratio Test. Applied Financial Economics, 5, 251-256. https://doi.org/10.1080/758536875
- Urrutia, J.L. (1995) Tests of Random Walk and Market Efficiency for Latin American Emerging Equity Markets. Journal of Financial Research, 18, 299-309. https://doi.org/10.1111/j.1475-6803.1995.tb00568.x
- Smith, G. and Ryoo, H.J. (2003) Variance Ratio Tests of the Random Walk Hypothesis for European Emerging Stock Markets. The European Journal of Finance, 9, 290-300. https://doi.org/10.1080/1351847021000025777
- Darrat, A.F. and Zhong, M. (2000) On Testing the Random-Walk Hypothesis: A Model-Comparison Approach. Financial Review, 35, 105-124. https://doi.org/10.1111/j.1540-6288.2000.tb01423.x
- Geweke, J. and Feige, E. (1979) Some Joint Tests of the Efficiency of Markets for Forward Foreign Exchange. The Review of Economics and Statistics, 61, 334-341. https://doi.org/10.2307/1926062
- Granger, C.W. (1986) Developments in the Study of Cointegrated Economic Variables. Oxford Bulletin of Economics and Statistics, 48, 213-228. https://doi.org/10.1111/j.1468-0084.1986.mp48003002.x
- Chan, K., Gup, B. and Pan, M.S. (1992) Market Efficiency and Cointegration Tests for Foreign Currency Futures Markets. Journal of International Financial Markets, Institutions & Money, 2, 78-89.
- Arshanapalli, B. and Doukas, J. (1993) International Stock Market Linkages: Evidence from the Pre- and Post-October 1987 Period. Journal of Banking & Finance, 17, 193-208. https://doi.org/10.1016/0378-4266(93)90088-U
- DeFusco, R., Geppert, J. and Tsetsekos, G. (1993) Emerging Capital Markets: Results from Cointegration Tests. The Annual Meeting of the Financial Management Association.
- Johansen, S. (1988) Statistical Analysis of Cointegration Vectors. Journal of Economic Dynamics and Control, 12, 231-254. https://doi.org/10.1016/0165-1889(88)90041-3
- Johansen, S. (1991) Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models. Econometrica, 59, 1551-1580. https://doi.org/10.2307/2938278