Efficiency and Volatility of the Stock Market in Bangladesh: A Macroeconometric Analysis

Abstract

This dissertation investigates the weak form efficiency of Efficient Market Hypothesis (EMH) employing Autocorrelation test, Runs test and Unit Root tests, and the nature of volatility characteristics of stock returns applying GARCH family models in Bangladesh stock market using daily all share price index return data of Dhaka Stock Exchange (DSE) from 02 January 1993 to 27 January 2013. The thesis also examines the semi-strong form of the EMH of DSE based on macroeconomic variable version of the Arbitrage Pricing Theory (APT) applying Cointegration tests, Vector Error Correction Model (VECM) and Granger causality tests, and the volatility of the DSE returns in response to the volatility of the macroeconomic variables employing GARCH family models using monthly data from January 2001 to December 2012. In addition, the short run and long run relationships between macroeconomic variables and aggregate stock prices in Bangladesh have also been determined. Employing both nonparametric tests (Runs test and Phillips-Perron test) and parametric tests (Autocorrelation test and Augmented Dickey-fuller test), this thesis finds that the Dhaka Stock Exchange of Bangladesh is not weak form efficient. The Johansen and Juselius multivariate cointegration tests reveal that industrial production index (IPI) and crude oil price (OP) have significant negative long run relationships with all share price index (DSI) of DSE, while money supply (MS), exchange rate (ER) and Indian stock prices (SENSEX) have significant positive long run relationship with all share price index of DSE. Results of VECM indicate that there is a long run causality running from IPI, M2, OP, ER and SENSEX to DSI. The error correction term of first differenced DSI implies that 15% of the last month’s disequilibrium becomes corrected monthly. The VECM results also show that DSI picks up the disequilibrium quickly and guides the variables of the system back to equilibrium. Results of VECM Granger causality/block exogeneity Wald test and Granger causality test reveal that individually IPI, CMR and SENSEX are the leading indicators with respect to stock prices in Bangladesh in the short run. Moreover, stock price index of DSE is a leading indicator with respect to IPI and ER in the short run. Taking the outcome of VAR models into account, it is found that all selected macroeconomic variables do significantly explain the stock prices of the Bangladesh stock market. As a consequence, it may be concluded that the Bangladesh stock market is not efficient in the semi-strong form of EMH. Results of the estimated MA(1)-GARCH(1,1) model show that the stock market of Bangladesh captures volatility clustering and the volatility is moderately persistent. The estimated MA(1)-EGARCH(1,1) model reveals that the effect of bad news on stock market volatility is greater than the effect induced by good news. Results of six GARCH-S models indicate that there is significant positive relationship between the changes in exchange rate (ER) and the volatility of DSE returns. Results also imply that the growth of the broad money supply (M2) and the volatility of Indian stock market (SENSEX) have significant negative relationship with the volatility of Dhaka stock exchange returns. Therefore, we can conclude that the stock market of Bangladesh is not efficient in weak and semi-strong form, and consequently, investors can earn abnormal profit using publicly available information. Stock market returns of Bangladesh exhibit leptokurtosis, volatility clustering and leverage effect or asymmetric volatility. The volatility of DSE return is significantly influenced by the volatility of macroeconomic variables such as ER, M2 and SENSEX.