ACKNOWLEDGEMENT

I express my gratitude to my supervisor, Kitty Moloney, for her continuous

cooperation and support without which I would have been unable to
complete my dissertation on time.

I sincerely thank Prof. Wallace Ewart for approving my dissertation topic

and providing useful tips throughout my research process.

I would like to thank our year head Mr Justin Keogan for his constant
support right through the process of my dissertation.

I, further, would take the opportunity to thank Mr. Soumya Choudhury,

Assistant Vice President and Mr. Kiran Deshmukh , COO of Sona Koyo
Steering Systems Limited for having helped me in contacting equity analysts
based in India and interviewing them.

I would like to express my sincere heartfelt thanks to my friends and

colleagues who stood by me throughout the dissertation process and indulged
themselves with the discussions in my work. They also gave their opinions
and time in reading the work repeatedly throughout the process.

1
 Table of Contents

1 INTRODUCTION…………………………………………… 1
2 LITERATURE REVIEW………………………………….. 4
2.1 The Mississippi Scheme…………………………………. 4
2.2 The South Sea Bubble…………………………………… 7
2.3 Tulipomania……………………………………………….. 7
2.4 The 1987 Crash of the NYSE and
The Internet Bubble………………………………………. 7
2.5 Investor Sentiment……………………………………….. 10
2.6 Random Walk and Market Efficiency………………….. 14
2.7 Behavioural Finance……………………………………… 20
2.8 Fashions and Fads………………………………………. 22
2.9 Age of the Stock Exchange…………………………….. 24
2.10 Information…………………………………………………. 25
2.11 Volatility and Macro-economic Variables………………. 28
2.12 Legal and Reporting Aspects……………………………. 30
2.13 Institutional Investors…………………………………….. 32
2.14 Analysing the Stock Markets…………………………… 33
2.14.1 Technical Analysis……………………………………….. 33
2.14.2 Fundamental Analysis…………………………………… 39
3 RESEARCH METHODOLOGY…………………………. 42
3.1 Types of Research……………………………………….. 44
3.1.1 Secondary Research…………………………………….. 44

2
3.1.2 Primary Research………………………………………… 45
3.2 Methodology Followed…………………………………… 46
4 FINDINGS AND ANALYSIS…………………………….. 54
4.1 Volatility and Macro-economic Variables……………… 54
4.2 Government Intervention…………………………………. 56
4.3 Impact of Interest Rates…………………………………. 57
4.4 Macro-economic Variables and Investor Sentiment….. 60
4.5 Random Walk and Market Efficiency………………….. 64
4.6 Accounting and Reporting Standards………………….. 66
4.7 Corporate Earnings Performance……………………….. 68
4.8 Market Direction………………………………………….. 69
4.9 Factors Impacting Market Movement…………………… 70
4.10 Good Performing Sectors………………………………… 71
4.10.1 Emerging Global Mindset………………………………… 73
4.10.2 Infrastructure Drive………………………………………… 74
4.11 Analysis of Stock Markets………………………………. 75
4.12 Information…………………………………………………. 78
5 CONCLUSION AND RECOMMENDATIONS………….. 81
5.1 Conclusion…………………………………………………. 81
5.2 Recommendations………………………………………… 87
5.3 Limitations and Scope for Further Research…………… 90
6 BIBLIOGRAPHY………………………………………….. 92
APPENDIX - I QUESTIONNAIRE DISTRIBUTED
AMONG RETAIL INVESTORS………………………….. 103

3
 List of Abbreviations and Key Terms used

Bear – Diminishing stock prices phenomenon.

BSE – The Stock Exchange, Mumbai.

Bull-run – Increase in the stock prices.

CNX 500 – NSE’s sensitivity index calculated considering 500 listed companies.

COO – Chief Operating Officer.

Day-traders – Traders who buy and sell stocks once or more than once a day.

EMH – Efficient Market Hypothesis.

FDI – Foreign Direct Investment.

FII – Foreign Institutional Investors.

GDP – Gross Domestic Product – Income generated within the customs frontiers

of a nation by the citizens of that nation and foreigners residing in the nation.

GNP – Gross National Product – Income generated from productive activities

undertaken by the citizens of a country irrespective of their country of residence.

ICAI – Institute of the Chartered Accountants of India.

ICFAI – Institute of Chartered Financial Analysts of India.

ICICI Bank – Industrial Credit and Investment Corporation of India Bank.

4
Inflation – General rise in the price level within an economy.

Intra-day Volatility – Fluctuations in the stock prices within a day.

IPO – Initial Public Offering.

Long-term – 12 – 36 months.

Medium-term – 6 – 12 months.

NASDAQ - National Association of Securities Dealers Automated Quotations.

Nifty – NSE’s sensitivity index calculated considering 50 listed companies.

NSE – The National Stock Exchange of India.

NYSE – New York Stock Exchange.

P/E – Price-Earnings Ratio.

RBI – The Reserve Bank of India – India’s central bank.

SEBI – Securities and Exchange Board of India.

SEC – Securities and Exchange Commission.

Short-term – Up to 6 months.

Sensex – Sensitivity index of the BSE.

S&P – Standard and Poor’s.

UPA – United Progressive Alliance.

WPI – Wholesale Price Inflation.

5
 1. INTRODUCTION

The Stock Exchange Mumbai (BSE) is the oldest stock exchange in India and
Asia that was founded in the 1850s on the streets of Mumbai. It was granted
permanent recognition under the Securities Contract Regulation Act, 1956 and
has grown over the last 150 years. Today the market capitalisation of the BSE
stands at more than $1,000 billion (India PRwire, 2007, online, p N/A). The BSE
SENSEX is the benchmark equity index that reflects the robustness of the
economy and finance. At par with international standards, BSE has been a pioneer
in several areas (Heritage, 2007, online).

With such a high market capitalization and the growth of the Indian economy
(GDP) at a rate of 8.6% per annum for the period 2003-07 (The Indian Economy:
Review and Prospects, 2007, online, p 3), the BSE also has shown a tremendous
growth during the period.

The upward movement of the BSE Sensex since 1998 with certain downfalls gave
rise to the thought whether this is a bull-run that exists on the BSE or is it a
bubble. The history of bubbles does not suggest that bubbles last for longer
periods of time. But referring to the Mississippi Scheme, the South Sea Bubble
and the Tulipomania, it becomes unambiguous that these bubbles took long to
burst. As time passed, the gaps between bubbles have shortened and the duration

6
for which the bubbles stay has declined. This can be understood if we look at the
1987 crash of the NYSE and the 2000 internet bubble.

SENSEX 1998-99 TO 2006-07

16000
14000
12000
10000
8000 Series1
6000
4000
2000
0
4/6/1998

4/6/1999

4/6/2000

4/6/2001

4/6/2002

4/6/2003

4/6/2004

4/6/2005

4/6/2006

Source: Data collected from www.bseindia.com and tabulated.

This research is based on the hypothesis – BSE can sustain the bull-run effect for
a long-term in the future with regards to positive investor sentiment. Further, this
topic was selected keeping in view my interest in the stock exchanges and love for
finance and also looking at the future career opportunities blooming in this field
of stock market research.
Bordo et al (2006) said that booms ended when monetary policy tightened in
response to rising inflation. India faced a similar situation of rising inflation in the
last fiscal year and is continuing in this fiscal too. The year-on-year (y-o-y)

7
inflation was 5.7 per cent as on March 31, 2007 as compared with 4.0 per cent a
year ago (Price Situations, RBI, online, 2007, p N/A). Pagan and Sossounov
(2003) explained the theory of euphoria and despondency and also marked that
booms arise when interest rates are low/falling and end with changes in fiscal
policies. The interest rates are rising in India wherein the prime lending rate has
gone up from 12.75% to 13.25% per annum as on 4th May 2007 as opposed to
10.75% to 11.25% on 5th May 2006 (RBI, 2007, online). Further they noted that
there is a negative correlation between stock prices and inflation. Thus, these lead
to the questioning of the sustainability of the bull-run experienced by investors on
the BSE for almost nine years excluding some downturns from time to time.
Bhattacharya and Chakravarty (1994) opined that behaviour of stock prices is
unrelated to key macro variables whereas Chaudhari and Koo (2001) found that
both domestic macroeconomic variables and international variables have
significant impact on stock return volatility. Their results also suggested that the
role of government in terms of fiscal and monetary policy in smooth functioning
of the stock market is crucial in emerging markets. India is recording a sound
macroeconomic growth in terms of its GDP and also the Ministry of Finance of
the Government of India is indirectly intervening in the stock markets of India.
Again the question arises if macro variables have an impact on the performance of
the BSE and whether positive march of the macro variables would have a positive
impact on the BSE whereby the bull-run can be sustained by the exchange in the
long-term. This paper tries to investigate if the BSE is facing a bull-run or is it a
bubble and if it is a bull-run the paper tries to find an answer to whether the bull
can run for two to three years from now.

8
 2. LITERATURE REVIEW

2.1 The Mississippi Scheme

The behaviour of investors and corresponding stock prices – volatility and the ups
and downs – have been observed from the early 18th century Europe. These
happenings can be explained going back to 1718 when John Law, a Scottish man,
introduced the concept of paper money in France (Mackay, 1982, p 1107-1153).
John Law came in close contact with the Duke of Orleans through his gaming.
The Duke became an admirer of John Law in due course of time. In 1715, when
King Louis XIV died, the heir to the throne was seven years old – a minor. The
Duke of Orleans acted as the Regent to the throne and for the minor successor. He
wanted to remove France out of the financial crisis that the country was facing.
During this time Law proposed his scheme of paper money instead of coins and
also his famous Mississippi scheme. (Mackay, 1982, p 1107-1153).
With a legislation passed in the French parliament, Law was allowed to set up a
bank that could issue notes. Law publicly declared at the opening of the bank that
a banker deserved death if he made issues without having sufficient security to
answer all demands. The result was that his notes advanced rapidly in public
estimation and were received at one percent more than specie. In course of a year,
Law’s notes rose to 15% premium while the billets d’etat (notes) issued by the
government, as security for debts, contracted by the extravagant Louis XIV, were
at a discount of no less than 78.5% (Mackay, 1982, p 1107-1153).

9
The Regent decided to issue 1,000 million livres. Thus the money supply (M3)
escalated in the economy. This was done without security held with the bank in
terms of precious metal. Political rivalry added to a further escalation of M3.
In due course, traders started business with India, China and the Asian kingdoms
– the affluent economies of the time. French traders formed the French East India
Company supported by the French government. The company declared a very
high (120%) dividend payout for the shares of the company. The public
enthusiasm, which had been so long rising, could not resist a vision so splendid.
Everyday the value of the old shares increased and the share price rose from 500
livres to 5,000 livres. An increased volatility was observed in the intra-day trading
of these shares. Many French tried their luck in these shares and the game of
fluctuating share prices. The basis was that of the Mississippi Company that the
Regent and John Law believed that investing in the swamp lands of Mississippi
would render high returns in the future due to the gold mines in the region which
they thought would not be extinct for quite a long time. Here the concept of future
expected earnings comes into force which seems to have driven the investors’
sentiments and also a support of the scheme from the government. Further, as
Law stated earlier at the inauguration of his bank that a banker deserved death in
case of a default, this could have added to a rise in the investors’ confidence
because of which the share prices – the value of paper money – sold by Law
started to increase fast (Mackay, 1982, p 1107-1153).
There was an overall growth in the French economy during the period with M3
being quite high in the hands of the people. Also foreigners started to come to
Paris to trade in the shares of this Mississippi scheme. Inflation was on a rise and

10
this was conducive to business within the country. Also foreign traders thought
this was a good scenario to trade with France and thus boosted France’s
international business. But in 1720 a major share holder in this company decided
to sell off his shares and demanded bank notes back. It was such a big amount that
it was not possible for Law to give the money back at once. The credibility of the
company was in question. Other shareholders followed by offering the shares for
sale. This created a panic situation in Paris and the value of the paper issued by
Law started falling. The Regent tried to control the situation and made some poor
people of France parade on the streets of Paris with their equipments and then
were shipped to New Orleans in America. But this did not help in restoring
investors’ confidence in the scheme. Law was found guilty of the fiasco of the
scheme and people started hating him.
From this great historical crash some things come forth to light. Investors believe
strong statements by promoter/s, sense signals within the market and determine
their demand based on what they expect to earn in the future. Moreover, when
demand exceeds supply, the prices tend to rise. There was an abnormal rise in the
prices of the shares issued by John Law and people started expecting
exceptionally high returns in the future. Also the case throws light on the fact that
those who involved in short trading were benefited from Law’s scheme but those
who were looking to long term benefits lost their money. Further a rosy picture
was painted of the Mississippi Scheme which the investors had no choice but to
believe due to lack of accounting or forecasting laws present at the time.

11
2.2 The South Sea Bubble (Mackay, 1982, p 1154 – 1179)
Similar situation was observed in the case of the South Sea Company that was
formed in Great Britain by a handful of anonymous traders. The company was
completely backed by the British government and the investors had a high level of
confidence in the said company. But a rosy picture of the future earnings was
painted by the governors of the company, which led to herding and high future
expectations among the investors. Resultantly the share prices started to raise
abnormally, which people believed was a sustainable phenomenon. The demand
for the shares exceeded vis-à-vis the supply and the share prices sore up.
Unfortunately, the Spanish king did not want to open the Mexican and Latin
American ports to the British for free trade, the expected future returns could not
turn up to the expectations. There was a panic amongst the investors who started
selling off the shares and a reverse situation was created whereby the supply far
exceeded demand. Suddenly the share prices dropped drastically which came to
be known as the burst of the bubble.

2.3 Tulipomania
Mackay (1982, p 1180) wrote that the tulipomania started in the Netherlands in
the early half of the seventeenth century. The demand for tulips of a rare species
increased so much in the year 1636, that regular marts for their sale were
established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem,
Leyden, Alkmar, Hoorn and other towns. Symptoms of gambling became
apparent with stockjobbers making use of all the means they so well knew to
employ to cause fluctuations in prices. At first, as in all these gambling mania,

12
confidence was at its height and everybody gained. Everyone imagined that the
passion for tulips would last forever and that the wealthy from every part of the
world would send to Holland and pay whatever prices were asked for them.
People of all grades converted their property into cash and invested it in flowers.
Houses and lands were offered for sale at ruinously low prices or assigned in
payment of bargains made at the tulip-mart. Foreigners became smitten with the
same frenzy and money poured into Holland from all directions. The prices of the
necessaries of life rose again by degrees.
At last, however, the more prudent began to see that this folly could not last
forever. Rich people no longer bought the flowers to keep them in their gardens
but to sell them again at cent per cent profit. It was seen that somebody must lose
fearfully in the end. As this conviction spread, prices fell and never rose again.
Confidence was destroyed and a universal panic seized upon the dealers.

2.4 The 1987 Crash of the NYSE and the Internet Bubble
The 1987 crash of the NYSE that is known as the black Monday, can also be
attributed to the herding and higher future expectations among the investors. The
Securities and Exchange Commission (SEC) had done its job of educating the
investors in the post-war era but it could not make the investors think. Infatuation
among the investors led to the crash of 19th October 1987 of the NYSE’s Dow
Jones Industrial Index. (Sahuraja, 2003, p 314-356).
Following the success of several early Internet initial public offerings (IPOs) such
as Yahoo (1996), Amazon (1997), and eBay (1998), an increasing number of
Internet firms went public. From January 1999 to February 2000, a total of 298

13
Internet companies went public in the US, more than doubling the number of
existing Internet stocks (O’Brien & Tian, 2006 [online], p 3). More astounding
than the growth of the number of public companies in the sector was the dramatic
rise in share values for Internet stocks. Liu and Song (2001) cite results compiled
by Pegasus Research International, showing that the two-year 1998-9 return on an
Internet index (INTDEX) exceeded 125%, compared with 85% growth in the
NASDAQ index and 19.5% in the S&P 500 index. However Internet stocks’
remarkable rise was eclipsed by their monumental failure in early 2000. Hiriam
(2000) reports that the 51% drop in the NASDAQ index during the year of 2000
was the largest stock market decline in the US since the Great Depression.
Seeking explanations for the apparent “bubble” of the late 1990s, some financial
observers blamed financial analysts for misleading investors. For example,
Malkiel (2002, p 16) writing in the Wall Street Journal, says, there has been no
credible proposal to deal with the issue of corrupted research, which surely
contributed to the bubble.
Commercially the internet started to catch on in 1995 with an estimated 18
million users. The rise in the usage meant an international market. Soon,
speculators were barely able to control their excitement over the new economy
(Sahuraja, 2003, p 314-356).
Companies underwent a similar phenomenon to the one that gripped seventeenth
century England. Investors wanted big ideas more than a solid business plan. The
IPOs of internet companies emerged with intensity and frequency, sweeping the
nation up in euphoria. Investors were blindly grabbing every new issue without
even looking at a business plan to find out how long the company would take

14
before making a profit, if ever. This was like building the castles in the air and
had a resemblance with the three bubbles discusses earlier in this paper.
This bubble can be attributed to high degree of imitation among the investors;
huge future expected earnings and high level of confidence in the sector (internet
business). But this was wrong and the investors were misled to an extent by the
analysts of the time as said earlier in this section of the paper.

2.5 Investor Sentiment

Barberis et al (1998) agree with De Long et al (1990), Lee et al (1991) that
investor sentiment, in part, is unpredictable. The authors say that the investors
observe earnings, and use this information to update their beliefs about which
state they are in. In a variety of markets, sophisticated investors can earn superior
returns by taking advantage of under reaction and overreaction without bearing
extra risk. (Barberis, et al, 1998, p 308).
Daniel et al. (1998) also construct a model of investor sentiment aimed at
reconciling the empirical findings of overreaction and under reaction. They have
used concepts from psychology to support their framework, although the
underpinnings of their model are overconfidence and self-attribution.
Abarbanel’s (1992) study examined whether security analysts overreact or under
react to prior earnings information and whether any such behaviour could explain
previously documented anomalous stock price movements. The data consisted of
primary earnings per share and corresponding Value Line forecasts, as well as
stock price information, for 178 firms and as many as 44 quarters in the 1976-86
period. The results indicate that analysts' forecasts under react to recent earnings,

15
which is consistent with certain properties of the naive seasonal random walk
forecast that underlies the anomalous post-earnings-announcement drift.
However, the under reactions are at most only about half as large as necessary to
explain the size of the drift. In addition, the study shows that the "extreme"
analysts' forecasts studied by DeBondt and Thaler (1990) cannot be viewed as
overreactions to earnings and are not clearly linked to stock price overreactions.
Sahuraja (2003, p 314-356) studied the 1992-93 crash of the Stock Exchange,
Mumbai (BSE) and also the 1987 NYSE crash alongside the 2000 Internet bubble
bust in his book The Stock Exchanges Paranoid and the Indian Economy. He
described about investor emotion through market cycle and said that investor
sentiment was generally euphoric in late 1999 and early 2000 when the U.S. share
market surged to its peak levels in March 2000. He specifically refers to the
Nasdaq index that surged as a result of the internet wave that swept in the western
world and also the developed nations of the world. Sahuraja says that the media
messages were very positive and certain best selling books stated that the Dow
Jones index would reach 36,000 mark.

16
 Investor Emotions through Market Cycles

Source: Frank Russell http://www.russell.com/US/about_russell/press_room/default.asp

Sahuraja (2003, p 331) suggests in this context that confidence and investor
psychology do not act in a vacuum. The move from despondency at the bottom of
a cycle to euphoria at the top is usually initially driven by favourable fundamental
developments, e.g. strong economic growth and undemanding monetary
conditions.
Lee (2006, online, p N/A) is of the opinion that major bull markets do not start
when investors are feeling euphoric and major bear markets do not start when
they are feeling depressed. The reason is that by the time investor confidence has
reached these extremes all those who wish to buy/sell have done so, meaning that
it only requires a small amount of bad/good news to tip investors back the other
way.
Dr. Oliver (2002, p 2) says that extreme low points in investor confidence are
often associated with market bottoms.

17
 Relation between Bulls and S&P 500 index.

Source: AAII, Investors Intelligence, Market Vane, Bloomberg

Shiller et al (1991) conducted a questionnaire survey of the Japanese institutional

investors to recall what they thought and did during the worldwide stock market
crash in October 1987. The results confirm that the drop in U.S. stock prices was
the primary factor on their minds, and other news stories in the United States
dominated Japanese news stories. A comparison with an earlier survey of U.S.
institutional investors at the time of the crash (R.J. Shiller, November 1987
“Investor Behavior in the October 1987 Stock Market Crash: Survey Evidence”,
NBER Working Paper 2446) shows a remarkable similarity between Japanese and
U.S. institutional investors in a number of attitudinal and behavioural dimensions.
The results suggest that events in the United States were the proximate cause of

18
the crash in Japan, but that the transmission mechanism of the crash was very
similar in both countries.

2.6 Random Walk and Market Efficiency

Kendall (1953) presented a paper before the Royal Statistical Society in London.
He examined the behaviour of stock and commodity prices in search of regular
cycles. Instead of discovering any regular price cycle, he found each series to be a
wandering one, almost as if once a week the Demon of Chance and added it to the
current price to determine the next week’s price (CHANDRA, 2003, 270). In
other words, the successive price changes were independent of one another which
Chandra terms to be a random walk. Roberts (1959) demonstrated that a time
series generated from a sequence of random numbers was impossible to
differentiate from a record of US stock prices - the raw material used by market
technicians to predict future price levels.
The mid-1960s was a turning point in research on the random character of stock
prices. In 1964, Cootner published his collection of papers on that topic, while
Fama's (1965) doctoral dissertation was reproduced, in its entirety, in the Journal
of Business. Fama reviews the existing literature on stock price behaviour,
examines the distribution and serial dependence of stock market returns, and
concludes in favour of the random walk hypothesis.
Chandra (2003, 288) claims that various studies point that the randomness of
stock prices was the result of an efficient market.
With a better understanding of price formation in competitive markets, the
random walk model came to be seen as a set of observations that can be

19
consistent with the efficient markets hypothesis (DIMSON & MUSSAVIAN,
1998, 3). Chandra (2003, 271) defined efficient market as the one in which the
market price of a security is an unbiased estimate of its intrinsic value.
Fama (1970) suggested that is useful to distinguish three levels of market
efficiency:
• Weak-form efficiency.
• Semi-strong form efficiency
• Strong-form efficiency.
Fama stressed in his research that a market could be deemed to be efficient, only
if we put forward a model for returns. From this point on, tests of market
efficiency became joint tests of market behaviour and models of asset pricing in
the research. These two should be jointly viewed, as market behaviour is an
important aspect in stock prices, returns and eventually the stock market indices.
Fama (1970) summarises the early random walk literature, his own contributions
and other studies of the information contained in the historical series of prices,
and concluded that the results were strongly in support of the weak form of
market efficiency. He then reviewed a number of semi strong and strong form
tests and concluded that in short, the evidence in support of the efficient markets
model was extensive, and (somewhat exclusively in economics) conflicting
confirmation was thin. Fama (1991) subsequently returned to the dispute with a
reinterpretation of the efficient markets hypothesis in the light of subsequent
research.
Dimson et al (1998) say that studies of the semi-strong form of the efficient
markets hypothesis can be categorised as tests of the speed of adjustment of prices

20
to new information. The principal research tool in this area is the event study. An
event study averages the cumulative performance of stocks over time, from a
specified number of time periods before an event to a specified number of periods
after. The first event study was undertaken by Fama, Fisher, Jensen and Roll
(1969). Using the market model or capital asset pricing model as the benchmark,
these event studies provide evidence on the reaction of share prices to stock splits
and earnings announcements respectively. In both cases, the market appears to
anticipate the information, and most of the price adjustment is complete before
the event is revealed to the market. When news is released, the remaining price
adjustment takes place rapidly and accurately. Particularly the Fama, Fisher,
Jensen and Roll study demonstrates that prices reflect not only direct estimates of
likely performance by the sample companies, but also information that requires
more fine interpretation.
Akerlof and Yellen (1987) argue that Keynesian economics are quite consistent
with the behavioural regularities documented by psychologists and sociologists.
The premise of their argument is that theory fitting the real world is based on
assumptions that individuals are not fully rational. Indeed, individuals may suffer
from money illusion, follow rules of thumb, or give weight to considerations of
fairness and equity in economic matters. Evidence indicates that individuals do
behave in such ways, and that the sticky money wages assumed in Keynesian
models are consistent with the known irrationalities of human behaviour. In his
(1966) book, On Keynesian Economics and the Economics of Keynes, Axel
Leijonhufvud made the distinction between the economics of the General Theory
(Keynes 1936) and the interpretation of Keynesian economics by Hicks and

21
Hansen that was incorporated into the IS-LM model and that forms the basis for
new-Keynesian economics. In that book, he pointed out that although the new-
Keynesians give a central role to the assumption of sticky prices, the sticky-price
assumption is a part of the mythology of Keynesian economics that is inessential
to the main themes of the General Theory. Whereas Keynes argued that the
general level of economic activity is determined in equilibrium by aggregate
demand, this idea is not present in new-Keynesian economics which views
unemployment as a short-run phenomenon that arises when prices are temporarily
away from their long-run equilibrium levels.
Brock (1995) is somewhat of a different view where he has proposed in terms of
the EMH. Brock (1995) states that proponents of behavioural finance point out
that real-world data do not fit the efficient markets paradigm very well. The
proponents do so, however, by assuming that investors are irrational and biased.
But to define someone as irrational is to presume the existence of a standard or a
benchmark of rationality. This presentation describes a new approach in which the
real-world behaviour of asset prices is not the result of investor irrationality but of
systematic mistakes investors make in their forecasts because of ignorance of the
true structure of the economy.
Dr. Oliver (2002, online) begins his article “Investment Insights” for Henderson
Global Investors by stating that until the 1980s the dominant economic theory was
that financial markets were efficient – in other words, that all relevant information
was reflected in asset prices and this was done in a rational manner. Faith in the
Efficient Markets Hypothesis (EMH) started to unravel through the 1980s.
However, the October 1987 crash was possibly the nail in the coffin of the EMH

22
as it was virtually impossible to explain why US shares fell over 30 per cent in a
two month period when there was scant new information to justify such a move.
He then directs the readers’ attention towards the Nasdaq crash, which was an
effect of high future, expected earnings from technology companies but
unfortunately the expectations did not live long and many companies in the
U.S.A. had to file for bankruptcy. This suddenly caused the investors’ confidence
to shake and shatter and the Nasdaq index started trading below 1200 from 5132
since 10th March 2000.
Dr. Oliver (2002, online, p 1) further states that in explaining the bull and bear
phases evident in asset markets (including residential real estate), it is not as
simple as saying that when investors are confident asset prices rise and when
investors are not confident, they fall. Rather, several aspects of behavioural
finance appear to interact, of which two aspects are key. He draws attention to the
facts that individuals are less than perfectly rational and the role of crowd
psychology or the herding effect.
Dr. Oliver (2002) goes a step ahead to say that the combination of lapses in
judgment by individuals when processing information and forming expectations,
and the underpinning effect played by crowd psychology, go a long way to
explaining why speculative surges in asset prices develop (usually after some
favourable fundamental development), and how they feed on themselves (as
individuals project recent price gains into the future, exercise “wishful thinking”
and receive positive feedback via the media, etc). Of course the whole process
goes into reverse once buying is exhausted, often triggered by contrary news to
that which drove the rise initially.

23
Alpert (1997, p 20) says that Nobel Prize-winning economists have long
contended that individual investors cannot consistently beat the overall market,
but in recent years, academics have found that stocks with specific characteristics
do routinely beat the market. Among the repeat winners are stocks that appear
cheap as measured by their book value, earnings, or cash flow. Three academics
who have made these findings are Josef Lakonishok at the University of Illinois,
Andrei Shleifer at Harvard University, and Robert Vishny at the University of
Chicago. What is most interesting is the trio's theory as to why such stocks
outperform: they credit systematic irrationalities in the thinking of even the sanest
people.
The early survey on the behaviour of stock return was done by Fama (1970). The
Fama Theory of efficient market hypothesis suggests that stock markets are
efficient because they reflect the fundamental macro economic behaviour. The
term efficiency implies that a financial market incorporates all relevant
information (including macro economic fundamentals) in the market, in which
case the outcome is the best possible under the circumstances.
Fama and French (1989) and Poterba and Summers (1988) have shown that the
U.S. stock returns have a mean reverting tendency and can be predictable to some
extent. Similar results have been found by MacDonald and Power (1991) that U.K.
stock returns have a mean reverting-tendency and so can be predicted. Subsequent
studies like Fama (1981), Fama and Gibbons (1982), Summers (1986) and Chen
(1991) verified that the efficient market hypothesis holds in US market, and there
was significant linkage between US stock market on one hand and real economic

24
variables, such as, GDP, industrial production, inflation and unemployment on the
other hand.

2.7 Behavioural Finance

Burr (1997) argues in favour of behavioural finance, a study of the markets that
makes use of psychology, is throwing more light on why people buy or sell
specific stocks or do not buy stocks at all. The tendencies of investors to make
mistaken analyses or have biases are at the core of behavioural finance. However,
other supporters apply behavioural finance to growth style or a hybrid of growth
and value; some find the theory's insights useful in their dealings with clients; and
others view the theory's insights as being useful in comprehending how and why
pension funds hire managers.
East (1993) conducted three studies in conjunction with behavioural finance to
test the investment decisions in privatised British industries. Study 1 was on the
regional electricity companies, Study 2 was on the electricity generating
companies and Study 3 was on the second tranche of shares in British Telecom.
The studies applied Ajzen’s (1991) theory of planned behaviour. In each case the
application for shares was accurately predicted by measured intention. Intention
was in turn explained by attitude, subjective norm, perceived control and past
behaviour. At a more specific level the research demonstrated the strong influence
of friends and relatives and the importance of easy access to funds as well as the
financial criteria of profit and security of investment. The research was used to
test aspects of planned behaviour theory and matters were considered in detail.
The first matter was the conditions under which a measure of perceived control

25
improved on the prediction of behaviour obtained from intention alone. The
second matter was the association between product sum variables and globally
measured variables; in the theory these are equated but rather low correlations are
often found.
Morris (1996) suggests that as traders learn about the true distribution of some
asset's dividends, a speculative premium occurs as each trader anticipates the
possibility of reselling the asset to another trader before complete learning has
occurred. Small differences in prior beliefs lead to large speculative premiums
during the learning process. This phenomenon helps explain a paradox concerning
the pricing of initial public offerings. The results cast light on the significance of
the common prior assumption in economic models.
Nagy (1994) argues that previous studies of retail investor behaviour have
examined motivation from economic perspectives or studied relationships
between economic and behavioural and demographic variables. Examination of
the various utility-maximisation and behavioural variables underlying individual
behaviour provides a more comprehensive understanding of the investment
decision process. These variables can be grouped into seven summary factors that
capture major investor considerations. Data collected from a questionnaire sent to
a random sample of individual equity investors with substantial holdings in
Fortune 500 firms reveal that individuals base their stock purchase decisions on
classical wealth-maximization criteria combined with diverse other variables.
They do not tend to rely on a single integrated approach.
Neumark et al (1991) observe that after-hours pricing in foreign equity markets of
multiple-listed U.S. securities appeared to be efficient in predicting New York

26
prices in the weeks immediately following the October 1987 crash but relatively
uninformative in succeeding months. By contract, daily changes in New York
prices appear to be efficiently incorporated in after-hours trading on both the
Tokyo and London exchanges throughout the sample period. This paper further
suggests that the asymmetry and temporal variations in cross-market correlations
are consistent with rational investor behaviour in equity markets with nonzero
transaction costs and time-varying share price volatility.
Olsen (1996) studies experts’ earnings predictions exhibit positive bias and
disappointing accuracy. These shortcomings are usually attributed to some
combination of incomplete knowledge, incompetence, and/or misrepresentation.
This article suggests that the human desire for consensus leads to herding
behaviour among earning forecasters. Herding results in a reduction in the
dispersion and an increase in the mean of the distribution of expert forecasts,
creating positive bias and inaccuracy in published earnings estimates. Investors’
mistake reduced dispersion for reduced risk and positive bias for high future
returns. These misperceptions lead to abnormally low returns from stocks with
unpredictable earning streams.

2.8 Fashions and Fads

Rosen et al (1991) study an important dimension of the ongoing trend toward
greater corporate social responsibility is the emergence of individual and
institutional investors who invest in companies that support social objectives.
While a small number of studies have examined the criteria used by institutions,
no studies have looked at individual investors. Using a mail survey of 4,000

27
investors in two mutual funds that incorporate social screens in their investment
decisions this study finds that compared with other investors, socially responsible
investors are younger and better educated. Respondents most frequently identify
environmental and labour relations issues when asked what defines socially
responsible corporate behaviour. Although the respondents value socially
responsible behaviour in companies they invest in, they are unwilling to sacrifice
financial returns to achieve it. This gives rise to another array of thought that
leads to checking the demographic composition of investors on the BSE and
mainly focusing on their age groups. Pandey (2003, p 1562) observed that
younger investors are inclined to taking more risks as compared to their older
counterparts because he inferred that the younger investors did not, by large, think
about post-retirement income as opposed to their older counterparts. Further, he
divided the Indian society by way of responsibilities shouldered and concluded
that unmarried singles were more risk takers in their early career ages than those
with family and children. He conducted a survey of 2000 investors that invest
using moneycontrol.com on the BSE and regressed the risks of portfolios of
various age groups and arrived at this conclusion. There can be a chance that if
the current investors on the BSE are younger, they may take more risk which can
cause the Sensex to keep high for comparatively longer period of time.
Damodaran (2004), Dalal (2003), Nair (2004) and Singh (2006) agree with the
opinions of Pandey (2003) in their studies carried out on the BSE, NSE, Karachi
Stock Exchange and the London Stock Exchange.
In his 1990 article “Market Volatility and Investor Behaviour” Shiller says that
fashions and fads can be found in stock prices far more than what is suggested by

28
the correlation between stock prices and dividends. As the correlation between
price and dividend is substantially a low-frequency one, and dividends
incorporate some of the fashions and fads that contaminate stock prices, the
author argues that the observed volatility of speculative prices and the pattern of
feedback of price to dividends/earnings are indicative of simple feedback models
of investor behaviour. Any tendency of feedback of price changes into price
should be regarded as reflective, instead, of a tendency to prejudice.

2.9 Age of the Stock Exchange

Galant (1995) gives the example of the University of Arizona professor Vernon
Smith. Prof. Smith has developed Arizona’s Economic Science Laboratory, where
students get to mock traders. The first time the students trade shares, there are big
bubbles. They recklessly bid up prices. But the second time around, the bubbles
are less dramatic. Investors ought to learn from their mistakes. A burgeoning field
of study called behavioural finance, which derives from behavioural economics, is
attempting to identify and learn from the particular human errors that are
characteristic of financial marketplaces. Behavioural finance strives to go beyond
investing wisdom to detect distinct modes of market behaviour. With a variety of
theories that range from the self-evident to the bizarre, behavioural finance strives
to go beyond folk investing wisdom to detect distinct modes of market behaviour
to guide investments. A key conclusion of behavioural finance is that a portfolio
of value stocks usually beats a portfolio of growth stocks. Glamour growth stocks
have too many exceptions embedded in their price, whereas value stocks are so
disliked they have nowhere to go but up.

29
2.10 Information
In Scholes' (1972) study of the price effects of secondary offerings, he examines
stock price movements when the seller may be in possession of non-public
information. On average, share prices fall by an amount that reflects the value of
this information. The impact of a secondary distribution on the stock price is
largely unaffected by the size of the transaction, which confirms the depth of the
market and the substitutability of one security for another. However there is some
indication of post-event price drift, which may constitute a violation of market
efficiency.
Bordo et al (2006) say that some economists claim that financial markets process
information efficiently. They claim to have found that booms generally occurred
during periods of above-average economic growth and below-average inflation,
and that booms typically ended when monetary policy tightened in response to
rising inflation.
Bordo (2003) finds that many, but by no means all U.S. and British stock market
crashes of the 19th and 20th Centuries were followed by recessions. A serious
decline in economic activity was more likely, he concludes, if a crash was
accompanied or followed by a banking panic. Mishkin and White (2003) come to
a similar conclusion in their review of U.S. stock market crashes in the 20th
Century. They found that a severe economic downturn was more likely to follow
a crash if the crash was accompanied by a widening of interest rate credit spreads.
Bordo et al (2006, 4) opine that there are episodes of price rise of stocks, which
they define as booms. This is also a bull run in the stock exchanges. They have
used the methodology of Pagan and Sossounov (2003) to identify prolonged

30
periods of rapidly rising real stock prices in ten countries for which monthly data
on a nominal stock price index and a consumer price index were available from
the early 1920s onward. They entail that market peaks and troughs alternate, and
so eliminate all but the highest maximum that occurred before a subsequent
trough, and all but the lowest minimum that occurred before a subsequent peak.
The real stock price indexes for Germany, Italy and Japan exhibit rapid growth
during the 1950s compared to average growth rates for subsequent decades i.e. the
post World War II period. They also find that booms typically have arisen when
interest rates are low and/or falling, and end following increases in policy rates.
They further state that there is a negative correlation between inflation and stock
prices. Earlier in their research, they suggest that stock prices reflect discounted
expected future dividends.
Domestic or foreign shocks of various sorts, including political events, wars, and
economic policies of other countries can affect stock prices. At times, countries
have used capital controls and other policies to wall off their domestic markets
from external forces, as well as to channel capital to specific uses. Various
domestic financial regulations, such as margin requirements and ownership
restrictions, may also affect the observed associations between stock prices and
macroeconomic conditions and monetary policy (Bordo, et al, 2006, p 9).
Notable economists as Fisher (1930) and, more recently, McGratton and Prescott
(2004) argue that economic fundamentals could justify stock prices even at the
U.S. market’s 1929 peak. Similar to the “new economy1” stories that appeared to

1
The Internet companies that thrived towards the turn of the century and a new avenue of business
and thus an economy altogether that was formed, has been termed as the “new economy”.

31
explain the stock market boom of the 1990s, advances in technology and
management practices were often cited in the 1920s as reasons why U.S.
corporations could expect high earnings growth that justified the large increase in
stock prices (White, 2006).
Despite a highly favourable macroeconomic environment, many economists
conclude that by 1929 U.S. stock prices far exceeded levels that could be justified
by economic fundamentals. DeLong and Schleifer (1991), for example, compare
the prices and net asset values of closed-end mutual funds and conclude that
stocks were some 30 percent overvalued in 1929. Rappoport and White (1993)
reach a similar conclusion from examining the premium on brokers’ loans.
Bouchaud and Cont (1998 [online], p N/A) propose a non linear Langevin
equation as a model for stock market fluctuations and crashes. This equation is
based on an identification of the different processes influencing the demand and
supply, and their mathematical transcription. They emphasize the importance of
feedback effects of price variations onto themselves. Risk aversion, in particular,
leads to an "up-down" symmetry breaking term which is responsible for crashes,
where "panic" is self reinforcing. It is also responsible for the sudden collapse of
speculative bubbles. Interestingly, these crashes appear as rare, "activated" events,
and have an exponentially small probability of occurrence. The model leads to a
specific "shape" of the fall down of the price during a crash, which we compare
with the October 1987 data. The normal regime, where the stock price exhibits
behaviour similar to that of a random walk, however reveals non trivial

Traditional businesses like the Ford Motor Company and all those of the industrial age and up to
the internet companies’ boom are called the “old economy”.

32
correlations on different time scales, in particular on the time scale over which
operators perceive a change of trend.

2.11 Volatility and Macro-economic Variables

Naj and Rahman (1991) studied the relationship between volatility of stock return
and of macroeconomic variables in four developed countries and confirmed the
relationships. Fung and Lee (1990) studied the long term relationships between
stocks return on the one hand and GNP, inflation and money supply on the other
in Taiwan and concluded that the efficient market hypothesis is not valid for an
emerging market. Fang and Loo (1995) studied the relationship between stock
return volatility and international trade for four Asian countries. They however,
found evidence in favour of the efficient market hypothesis.
The behaviour of stock price (BSE) in relation to some key macro economic
variables in India during the scam period 1992 was studied by Bhattacharya and
Chakravarty (1994). Their dynamic forecasts indicate that the behaviour of stock
price is unrelated to key macro variables.

Chaudhuri and Koo (2001) investigated the volatility of stock returns in some
Asian emerging markets in terms of the volatility of domestic and external factors
and found that both domestic macroeconomic variables and international
variables have significant impact on stock return volatility. Their empirical results
suggest the presence of a significant contamination effect and integration of
capital market in this region. The results also suggested the role of government in
terms of fiscal and monetary policy in smooth functioning of the stock market is
crucial in this region.

33
In a study published at the beginning of the nineties, which is essential in the new
line of thought, Levine (1991) points out the two key arguments: stock exchanges
speed up the economic growth in two ways. The first is by making property
changes possible in the companies, whilst not affecting their productive process;
the second is by offering higher possibilities of portfolio diversification to the
agents.
Demirgüc-Kunt and Maksimovic (1998) found a relationship between the rhythm
of economic growth and the stock market activity in the field of transmission of
securities (secondary market) more than in funds channelling (new emissions or
primary market). The same authors, in a study carried out in 1996, with a sample
of 30 countries for the 1980-1991 period, drew the following conclusions: stock
market advances in emerging countries do not imply a decrease of banking
business in the financing of business, but, on the contrary, lead to higher activity
in banking systems. Banks and markets do not appear, therefore, as alternative or
rival institutions, but are complementary to each other, reinforcing the whole
activity of the financial system.
New theoretical works show how stock markets might boost long-run economic
growth, and new empirical evidence supports this view. Specifically, the level of
stock markets development does a good job of predicting future economic growth.
This aspect is important for the World Bank and policymakers in developing
countries because it means that in many countries capital markets reforms should
be high on the reform agenda. (Demirgüc-Kunty Levine, 1996, p. 224).
On 23 February 2004 AME Info fn (online, p N/A) reported that the change of
regime in Iraq and the new economic policies underlined by the new government

34
would mean that not only the risk premium attached with Kuwait has seen
permanent reduction but also the business environment is all set to record steady
growth rates in the next couple of years. The article also observed that the
confidence shown by the investment community in the last couple of years was
going to last for a longer time than it has in the past. The author of this article
stated that a stable political and economic environment has always been able to
attract investor globally. The same article gives an overview of some of the
prominent sectors in Kuwait’s economy such as the oil and petroleum, transport
and distribution and banking and relates the overall performance of the companies
within these industries to be contributing factors towards the building up of
investor’s confidence.

2.12 Legal and Reporting Aspects

Important laws were enacted in the U.S. to regulate the issuance and trading of
securities such as the Securities Act of 1933, which required that investors receive
material information about securities being offered for sale, and the Securities
Exchange Act of 1934, which established the Securities Exchange Commission as
the principal federal agency responsible for oversight and enforcement of federal
securities laws. (Bordo, et al 2006, p 18). Bordo (2006, p 21) observed that during
the 1970s Australia and Canada experienced a boom in the stock prices where
energy and mining stocks had relatively heavy weights in the stock indexes. This
gives rise to another avenue of thought that suggests that the weights of stocks on
a stock exchange leave a huge impact on the investing decisions.

35
The market prices can be justified by the theory of equilibrium prices described
using the economic theories of supply and demand (AHUJA, 2003, 317). The
theories say that ceteris paribus, market players determine the price at which a
stock of commodity is offered for sale and bought. This depends on the quantity
of goods or services supplied in the market for sale and the quantity of the same
goods or services demanded.

14

12

10
Quantity

8
Qty. Demanded
6 Qty Supplied

0
1 2 3 4 5 6
Price

Demand – Supply Equilibrium Price

Prof. Penman (2003, [online], p. 77) says that during the recent stock market
bubble, the traditional financial reporting model was assailed as a backward-
looking system, out of date in the Information Age. With the bursting of the
bubble, the quality of financial reporting was again under scrutiny, but now for

36
not adhering to traditional principles of sound earnings measurement and asset
and liability recognition. His work is a retrospective on the quality of financial
reporting during the 1990s. He questions whether reporting under U.S. GAAP
performed well during the bubble or was its quality suspect. He suggests that
financial reporting should serve as an anchor during bubbles, to check speculative
belief. With a focus on the shareholder as customer, the paper asks whether
shareholders were well served or whether financial reporting helped to pyramid
earnings and stock prices. The scorecard was mixed. A number of quality features
of accounting were identified; inevitable imperfections due to measurement
difficulties were recognised, as quality warning to analysts and investors. A
number of failures of GAAP and financial disclosures were identified that, if not
recognised, can promote momentum investing and stock market bubbles.

2.13 Institutional Investors

Bertoni et al (2005 [online], p 38-42) state that the dynamics of equity risk
premium is not directly measurable on the market. Numerous studies and
empirical research analyse its volatility also considering the time span, concluding
that the dynamics of equity risk premium over time is inversely proportional to
the economic cycle. This study analyses the role of institutional investors in the
stock market context. In reality, savings management is delegated to a small
number of professional operators (institutional investors), as opposed to pure
theoretical models in which every person can act directly on the market thus
ensuring unlimited price elasticity. Institutional investors should be rational and
completely informed so that they can assume an anti-cyclical position on the

37
market. Thus, supply and demand should quickly smooth over emerging price
pressures and avoid price bubbles. The authors have analysed one possible
explanation for this situation not to occur, namely, that professionals suffer from
that three factors reduce the freedom of institutional investors to manage their
portfolios – the market target size, the fund structure, and the benchmarking.

2.14 Analysing the Stock Markets

2.14.1 Technical Analysis
The past price patterns described by Daniel and Titman (1999, p 37) throws light
on another avenue of analysing the markets using technical analysis. Chandra
(2003, p 409) says that technical analysts analyse internal market data with the
help of charts and graphs. They view the investment game as an exercise in
anticipating the behaviour of market participants. They look at charts to
understand what the market participants have been doing and believe that this
provides a basis for predicting future behaviour. On page 410 Chandra (2003)
states that because of persistence of trends and patterns, analysis of past market
data can be used to predict future prices. According to Fama (1970) this can be
related to weak form market efficiency that studies the past trends to base its
future expectations on.
Chandra (2003, p 420) identifies three sentiment indicators – short-interest ratio,
mutual fund liquidity and put/call ratio.
Short interest ratio is obtained by dividing total number of shares sold short by the
average trading volume. Investors sell short when they expect the prices to fall.
So when the short interest ratio is high it means that most investors expect the

38
price to fall. However, a technical analyst considers a high short interest ratio as a
sign of bullishness.
According to the theory of contrary opinion, if mutual fund liquidity is low, it
means that the mutual funds are bullish. So contrarians argue that the market is at,
or near, a peak and hence is likely to decline. Thus, low mutual fund liquidity is
considered as a bearish indicator.
Speculators buy calls when they are bullish and buy puts when they are bearish.
Since technical analysts believe that speculators are generally wrong, they
consider put/call ratio as a useful indicator. Jawale1 has a strong positive opinion
about speculators being wrong and Ramdas and Bijlani 2 agree with Jawale.
Technical analysts believe that rise in the put/call ratio is a buy signal and vice
versa.
Hagstrom (1994, p 132) has described the investment strategies of Warren Buffett
in his book titled The Warren Buffett Way: Investment Strategies of the World’s
Greatest Investor. The key beliefs of the Warren Buffett way are:
• Turn off the stock market.
• Do not worry about the economy.
• Buy a business, not a stock.
• Manage a portfolio of business.
These seem to hold good for a long term investor as in the short run the economic
movements have a high degree of correlation with the stock prices. Sant 3 said

1
Jawale is the Investment Analyst for American Express Bank, Mumbai.
2
Ramdas and Bijlani are technical analysts working with Economic Times.
3
Sant is an economist having worked for National Council for Applied Economic Research for
around 30 years and retired as a Senior Economic Research Analyst.

39
affirmative to this referring to the monetary discretionary measures adopted by
the Federal Reserve Bank, Bank of England and the Reserve Bank of India in
various situations in a guest lecture at TASMAC, India on 7th June 2003. This
asserts with the Keynesian approach that suggests that high returns generated in
any economy eventually lead to unreasonable inflation. At this point of time the
central bank of a nation has to intervene and reduce the money supply (M3) in the
economy, which is done by rising the prime lending rates. This is the easiest and
the foremost tool that the central banks use in situations of unprecedented
inflationary situation said Chandiramani1 in a guest lecture at TASMAC, India on
28th February 2003 while she was commenting on the union budget of India that
was reviewed live. She further added that in such situations cheap financing
options to invest in high yielding options seize to exist or at least minimise,
forcing the demand for shares to drop and adverse situations can be created that
can cause the stock markets to crash, or adjust themselves to overvaluations.
John Templeton also suggests that the game is about investing and not speculating
(Train, 1989, p 178). Templeton further has suggested buying individual stocks
and not market trends or economic outlook because individual stocks determine
the market and not the vice-versa. He has stressed on the fact that investors should
not panic. But many situations observed earlier as in the Mississippi Scheme,
South Sea Bubble, Tulipomania and the Internet Bubble have caused the bubble
to burst due to panic among other reasons. It can be argued that although a bubble
cannot be avoided for some reasons, partial avoidance of panic can help prevent

1
Dr.Jyoti Chandiramani is an economist and the Head of Department of Economics at the
University of Pune.

40
bursting of the bubble. Fisher and Statman (2002, p 17) opine that stock market
bubbles are created when stocks are overvalued, but bubbles are difficult to
detect, as value is difficult to measure. They conducted a survey of investors on
the U.S. stock exchanges and concluded that investors tend to focus on the
behaviour of markets. They further observed that individual investors thought that
the stock market was in a bubble in the late 1990s and the early 2000 and
expected the bubble to inflate; the proportion of investors who thought that the
stock market was overvalued was high in the late 1990s and the early 2000 and so
was the proportion of investors who thought it was a good time to invest.
They further observed that individual investors were an optimistic group,
especially about their own fortunes and the long-term fortunes of the stock
market. Individual investors expected higher stock market returns over the
following 10 years than over the following 12 months and they expected higher
returns on their own portfolios than on the stock market as a whole.
Fisher and Statman (2002, p 22) further say that the ups and downs of the stock
market shook the optimism of individual investors about their short-term fortunes
but their optimism about the long-term remained strong. The proportion of
investors who were optimistic about their investment targets during the following
12 months declined substantially along with the decline in the stock market, but
there was little change in the proportion of investors who were optimistic about
reaching their investment objectives over the next five years.
Peter Lynch (1990, p 92) he relied on fundamental analysis and eschewed
technical analysis. He looked at the price-earnings (P/E) ratio carefully. He
inferred that generally a P/E ratio that is twice the growth rate is very negative.

41
Other factors, he says, to be considered are the cash position, the debt factor,
dividends, book value, cash flow and profit after tax. He further goes on to
suggest that one must remain invested in the stocks if the fundamentals continue
to be good. Chandra (2003, p 562) says Peter Lynch to be the most successful
money managers of the time. Soros (1987, p 43) believes that the financial world
is unstable and chaotic and governed by mass psychology or herd instinct. He
suggests that the classical theory of economics, that holds that there is an
equilibrium price which represents the market-clearing price, does not exist.
On page 48 in his book The Alchemy of Finance, Soros says that –
The generally accepted view is that the markets are always right – that is market
prices tend to discount future developments accurately even when it is unclear
what those developments are. I start with the opposite point of vies. I believe that
market prices are always wrong in the sense that they present a biased view of the
future. But distortion works in both directions: not only market participants
operate with a bias, but their bias can also influence the course of events.
When the Berlin Wall came down on 9th November 1989, many people believed,
or at least hoped, that a new unified Germany would rise and prosper. Soros
(1987, p51), however, felt that the new Germany would experience difficulty in
financing the unification, remain preoccupied with its internal economic problems
and pay less attention to other western European countries. Germany, although
today is a major economic power of the European Union and Euro zone,
experiences disparity in the overall development of the Eastern and Western
German regions. Berlin has evidence of development but the overall demand for
housing in the region is poor due to slow economic development and flourishing

42
of businesses. This provides evidence of economic development and government
policies in the rise of stock market indexes.
David Dreman1 (1998, p 29) also eschews trend analysis approach and believes in
the ideology of fundamental analysis. He goes a step ahead to say that one should
not believe experts. Chandra (2003, p 568) suggests that current psychological
research suggests that man is primarily a serial or sequential processor of
information. He can handle information reliably for problems that require
essentially linear processing of information. However, many decision situations,
including investment decision situations, require configured or interactive
reasoning and not linear reasoning.
Chandra (2003, p 576-77) suggests that Chandrakant Sampat2 relies primarily on
publicly available information and a well-crafted investment philosophy. He says
that an investor must be able to visualise the future. For this purpose he focuses
on the cash flows and sticks to the fundamentals and also boldly suggests
purchasing when the market is plagues by panic. Nimesh Shah3 believes in doing
through research of the companies that he invests in. this is in line with Warren
Buffett’s philosophy of investing in businesses and not stocks.

1
David Dreman is the Chairman and Chief Investor of Dreman Value Management, a firm that
manages several billion dollars of individual and institutional funds and has a very impressive
track record.
2
Chandrakant Sampat is a highly informed and successful senior investor of India.
3
Chandra (2003, p 577) describes him as India’s largest individual investor. Nimesh established a
formidable record at an early age.

43
2.14.2 Fundamental Analysis
Varma (2006, p 128-149) suggests that an analyst has a variety of tools available
to choose the best that suits his/her specific purpose. He proposes two methods
broadly – ration analysis and funds flow analysis.
Ratio Analysis
Ratios are well-known and most widely used tools of financial analysis. A ratio
gives mathematical relationship between one variable and another. Though
computation of a ratio involves only a simple arithmetic operation, its
interpretation is a difficult exercise. The analysis of a ratio can disclose
relationships as well as basis of comparison that reveal conditions and trends that
cannot be detected by going through the individual components of the ratio. The
usefulness of ratios ultimately depends on their intelligent and skilful
interpretation.
Financial statement analysis is oriented towards the achievement of definite
objectives. The analysis of a ratio gives the relationship between two variables at
a point of time and over a period of time. There are three kinds of ratios and they
are liquidity ratios, profitability ratios and ownership ratios. Liquidity ratios
measure the short-term liquidity of the firm with the help of ratios like current
ratio, quick ratio and turnover ratios. Profitability ratios measure the operational
efficiency of the firm. They give details of how efficient the firm is in applying tis
resources to get the maximum returns. Ownership ratios help the present or future
stockholder in assessing the value of his investment. Earning ratios, leverage
ratios and dividend ratios fall into the category of ownership ratios. Leverage

44
ratios measure the long-term solvency of the firm. They are further divided into
capital structure ratios and coverage ratios.
Du Pont analysis divides a particular ratio into components and studies the effect
of each component of the ratio comparative analysis gives an idea where a firm
stands across the industry and studies its financial trends over a period of time.
Problems in Financial Statement Analysis
Development of Benchmarks – Many companies have operations spread across
a number of industries. As no other company may have a presence in the same
industries, that too in the same proportion, development of a benchmark becomes
a problem. Even when the company is not a diversified one, figures for the
various firms are needed in addition to the industry average.
Window Dressing – Firms may window-dress the financial statements in order to
show a rosy picture. In such a case, the whole exercise of analysing the statements
becomes useless. In order to draw some meaningful results out of the analysis, the
average figures over a period of time should be looked into.
Price Level Changes – Financial statements do not take into account changes in
price levels. Analysis of such statements may not give a true picture of the state of
affairs.
Differences in Accounting Policies – Different companies may follow different
accounting policies in respect of depreciation, stock valuation, etc. Comparison
between the ratios of two firms following different policies may not give the true
result.
Interpretation of Results – A problem may arise on two accounts –
interpretation of ratio on its own and interpretation of all the ratios taken together,

45
it is difficult to decide the optimum level of a ratio, in spite of the presence of
industry averages.
Correlation among Ratios – There may be a high degree of correlation among
the various ratios calculated, due to the presence of some common factor. This
may make interpretation of all the ratios confusing. Hence it becomes essential to
choose a few ratios, which can convey the required information.

To conclude, decision theorist Howard Raiffa (1968, p 174) introduces useful

distinctions among three approaches to the analysis of decisions. Normative
analysis is concerned with the rational solution to the decision problem. It defines
the ideal that actual decisions should strive to approximate. Descriptive analysis is
concerned with the manner in which real people actually make decisions.
Prescriptive analysis is concerned with practical advice and help that people
could use to make more rational decisions.
Kahneman et al. (1998, p 1) say that financial advising is a prescriptive activity
whose main objective should be to guide investors to make decisions that best
serve their interests. To advise effectively, advisors must be guided by an accurate
picture of the cognitive and emotional weaknesses of investors that relate to
making investment decisions: their occasionally faulty assessment of their own
interests and true wishes, the relevant facts that they tend to ignore, and the limits
of their ability to accept advice and to live with the decisions they make.
The articles discussed here throw light on some of the key factors that can cause
bubbles in the stock markets. They can be listed as under:
• Market efficiency.

46
• Imitation and herding effect.
• Limited knowledge of the investors about the market.
• Reporting standards – there can be manipulations in reporting and making
of financial statements that may lead to painting of a rosy picture of a
particular company.
• High expectations of the investors from particular companies or industries.
• Information digestion and reaction over the information.
• Risk taking attitude of the investors by large.
• Brokers’ role in investing decisions.
• Investors’ investing in stocks and not in businesses

47
 3. RESEARCH METHODOLOGY

The literature review rendered answers to generally posed questions relating to

the stock markets with focus on investor’s behaviour. The historical bubbles such
as the Mississippi Scheme, South Sea Bubble, and Tulipomania were studied and
so was the very recent bubble – the Internet bubble to find the causes of bubbles
in general. Overreaction, unjustifiable high expectations, and building the castles
in the air1 were some of the reasons for these bubbles to happen.
The works of Fama (1970), Fama and French (1989), Poterba and Summers
(1988), MacDonald and Power (1991), Fama (1981), Fama and Gibbons (1982),
Summers (1986) and Chen (1991) verified that the efficient market hypothesis
holds in US market. US market was considered as a benchmark due to the fact
that in terms of the market capitalisation of the domestic companies quoted on the
exchanges, NYSE's $13,000bn is the biggest, followed by Nasdaq at $3,600bn
and London at $3,000bn, Euronext at $2,700bn, Deutsche Börse $1,200bn, and
the exchanges of Spain at $959bn and Italy at $788bn (Europe’s World [online], p
N/A). The literature review confirmed that there exists a herding effect among the
investors in most of the stock markets and crowd behaviour left mature markets
like Nasdaq vulnerable.

1
A term used to express building expectations without the knowledge of a particular happening.
People expected super normal profits from businesses that nobody knew nor was there any past
record of the companies or similar kind of businesses to forecast the future.

48
There was a need to look at the investors’ knowledge in the BSE and also the
views of analysts of the BSE. After having done the secondary research, a base
for primary research was created which led to field work.
The field research could have been conducted in many ways. This discussion
leads to the ways of primary research and the ways adopted for this dissertation.

3.1 Types of Research

Research can, broadly be separated into two parts – primary research and
secondary research.

3.1.1 Secondary Research:

Secondary analysis is the reanalysis of data for the purpose of answering the
research question with better statistical techniques or answering new questions
with new data (Glass, 1976, p 3). Secondary analysis is an important feature of
the research and evaluation enterprise. Some of the best methodologists have
pursued secondary analysis in such a good style that it has eclipsed the
importance of primary research. Secondary research gives insights about the
research question and brings forth the existing facts and findings that can form a
base to a particular research. This type of analysis is used to build a foundation for
any kind of research and find gaps in the area of study where a new researcher can
conduct his/her research. These gaps lead to forming the parameters for primary
research.

49
3.1.2 Primary research:
Primary analysis is the original analysis of data in a research study. It is what one
typically imagines as the application of statistical methods (Glass, 1976 [online],
p 3). A few methods of primary research are as under:

Postal Survey (Primary Research Methods [online]) – This is typically a

quantitative method and can be done using either traditional postal mechanism or
using electronic mailing system. Questionnaires are sent out in this method that
have pre-coded and open-ended questions. In both the cases the cost is low
(negligible in the case of electronic mails). But the response rate can be poor as
many people do not take interest in reading such mails. The answers can be
incomplete or undesired as there is no contact with the person collecting the data.
Further, the responses are precoded and must be simple so people can understand
them – sometimes this means the quality of information provided is lower.

Telephone Survey (Primary Research Methods [online]) – This is again a

quantitative method that is cost effective of achieving robust sample allowing
generalisations to be made. The responses are pre-coded and certain groups do not
have access to the telephone so may be excluded from the sample. Further, it is
difficult to ask sensitive questions over the telephone and in some cases the
telephonic conversations may be recorded for data security reasons.

Face to Face Survey (Primary Research Methods [online]) – Another

quantitative method of primary research that includes both open questions and

50
pre-coded questions, which can achieve robust sample allowing generalisations if
sufficient numbers are surveyed. It is, though, an expensive and time-consuming
effort to the administrator. But it is ideal for gathering sensitive information or
exploring complicated issues.

In-depth Interview (Primary Research Methods [online]) – This is a qualitative

method of research whereby rich and detailed information can be gathered.
Interviewer is allowed more flexibility and discussions take place in great detail.
The major drawbacks of this method are that answers to open questions can be
difficult and time consuming to analyse. Also the discussions can be shadowed by
interviewee’s biases or area of specialisation. It is a very expensive and time-
consuming process and difficult to fix appointments with interviewees.

Focus Group (Primary Research Methods [online]) – It is a qualitative method

that involves discussion with around eight to twelve people and lasts for around
one to three hours. This method capitalises on the interaction between participants
where the participants are not representative of wider population that does not
allow for generalisations. This method is vital for gathering sensitive data and
requires careful and unbiased analysis.

Case Study (Primary Research Methods [online]) – This is another qualitative

method of primary research where the researcher gains understanding of a
specific person’s experience through an in-depth interview. It provides good

51
quotations and rich data that can bring alive other research, such as survey data.
Findings of this type of research cannot be generalised to a wider population.

3.2 Methodology followed

The starting point of this work was designing a hypothesis around a subject of
interest. Having vaguely designed a hypothesis, testing of the feasibility of this
hypothesis began in the early stages by way of preparing an initial draft of the
dissertation. Various existing pieces of work were read using mainly the database
http://www.moodle.gcd.ie that is provided by the library of Griffith College
Dublin. This is considered to be an online library and has a high level of
authenticity with regards to the material published thereon. Other authentic
websites such as that of the NYSE, Nasdaq, Deutsche Bourse, Euronext, BSE and
NSE were used during this process. Further, newspapers such as the Financial
Times and the Economic Times were used to refer to current happenings in the
world related to stock exchanges and fiscal policies of various economies. Further,
Social Sciences Research Network online database and ICFAI’s online database
were used to refer to numerous pieces of work.
The next step was to design a final draft that had a redesigned hypothesis, which
concentrated on the sustainability of the Bull Run. The same sets of databases
were used to finalise the research topic.
The literature review of this work is an attempt to throw light on what bubbles are
and the way they were caused in the past. This was followed by the works of
eminent academicians and researchers to probe the academic and practical
implications of bubbles on the economy and the investors’ psychology that gave

52
rise to bubbles. Also the literature review section analysed the role of government
and regulatory bodies in maintaining confidence in various stock exchanges and
avoiding the generation of bubbles. The legal component has also been touched
with a discussion of the Sarbanes-Oxley Act passed by the US Congress as a
result of the Enron accounting scam. This study left some gaps within itself, the
answers to which had to be found by conducting a field research. This was the
point where designing the primary research was felt and the process for primary
research begun.
As discussed earlier in this chapter, there were many tools of primary research
available but questionnaires and in-depth interviews were chosen for the purpose.
The research focus group was divided into two categories – retail investors and
analysts and high net worth individuals (HNIs).
Questionnaires were chosen as it was quite easy to reach many retail investors
using this method. Mostly these were distributed using contacts such as my
friends working in big organisations and brokers. My friends working in big
organisations like ABN Amro, Maersk Sealand, Accenture, Siro India, American
Express Bank, State Bank of India, ICICI Bank and a few other places distributed
these questionnaires among their colleagues in their respective organisations. Also
my father, being a stock broker, distributed these questionnaires among his clients
and through some other brokers. Using these networks 863 questionnaires were
distributed of which 194 people responded. [Please refer to Appendix - I on p 103
for the questionnaire]. Although this group may not be able to represent the 5
million odd retail investors on the BSE (Figures received from an internal source
of National Securities Depository Limited on terms on anonymity) due to a very

53
small number, the time frame for this research did not permit reaching more
numbers. Further, the questionnaires could not allot enough space for the retail
investors to express them vividly as it was done at their workplaces. There were
some problems at certain organisations to take these questionnaires in as there
was a suspicion of data leakage. ABN Amro and ABN Amro Central Enterprise
Services is on example of this doubt where I had to explain the security officials
about the purpose of my research and after having scrutinised the questionnaire,
they allowed me to circulate it in their organisation. This process of scrutiny took
me a day and I was not allowed to go an speak to any of the respondents – not
even to brief them about what research I was conducting and what was I looking
to find from their responses. This was true with all financial organisations except
for State Bank of India where my father held a senior position and worked for
more than twenty-five years.
Moreover, respondents did not answer all the questions in the questionnaires that
hinders further analysis and for which generalisations have to be made. This may
render some unrealistic answers but it helps in opening avenues for any further
research and gives a clear idea of the time-frame that shall be required to conduct
research in a particular sub-area within this broad area of bull-run.
To add to these problems, it was all quite expensive to print the questionnaires
and distribute them among these 863 respondents. Also, had the answers been
received from more than 194 respondents, it would be of a great help as only
0.00388% of the retail investors responded which is quite a low figure to analyse
the behaviour of the entire 5 million retail investors. There are many more
investors who prefer to invest their money in mutual funds or through financial

54
planners. They do not keep much track of the stock market happenings as they
have already transferred their responsibility to another person such as the fund
manager or financial planner.
These questionnaires were aimed at evaluating –
• The knowledge of retail investors about the BSE – questions 3, 4, 5, 6, and
8 were directed towards this purpose.
• Developing a relationship between the income levels and amount of
investments in equities – questions 1 and 2.
• Risk carrying nature of investors – questions 10 and 11.
• Forecasting the markets to know the market movements – questions 3 and
4.
• Questions 12, 13, 14 and 15 were directed towards analysing various
general parameters such as the correlation between age, occupation,
qualifications and gender with knowledge and risk carrying attitude
among the retail investors.
This was keeping in view the increasing effect of middle class and investing in
mutual funds by these retail investors (Jawale, 2005, p 83) that impacts the money
in circulation on any stock exchange and its effect on the volatility of the stock
exchange. This shall be discussed in the later sections of this paper.
Another tool used for the primary research was in-depth interviews with sixteen
analysts within the industry, seven practicing chartered accountants, five bankers
and two HNIs. The broad framework of these discussions revolved around the
following aspects –
• Types of investors.

55
 • Impact of mergers and acquisitions.
• Cross-border listing of Indian firms.
• Listing of MNCs on the BSE.
• Accounting and Reporting Standards.
• Stake holding of NYSE, Deutsche Bourse and Singapore Stock Exchange
(SGX).
• Present earnings, future expectations and predictions about the upcoming
sectors and companies within those sectors.
• Political stability and economic growth.
This was basically done to ascertain the volatility of the BSE in future and also to
understand how this will impact the sustainability of the rising sensex. Since these
analysts publish their views using print or TV media or advice their clients,
mainly institutions, their views may have a great impact on the way they perceive
this market movement in the future towards the sustainability of the rising sensex.
Following analysts participated in these interviews –
1. Mahantesh Sabarad, Prabhudas Liladher.
2. Pramod Amthe, ABN Securities.
3. Huzefa Suratwala, Angel Broking.
4. Tejas Trivedi, Anvil Share Brokers.
5. Bhavesh Dalal, B & K Securities.
6. Achala Kanitkar, DSP Merrill Lynch.
7. S. Ramnath, SSKI Securities.
8. Jamshed Dadabhoy, Citigroup.
9. Aniruddha Datta, Credit Lyonnai’s.

56
 10. Shyam Agarwal, Dawnay Day.
11. Ravi Agarwal, J.P.Morgan.
12. Shilpa Gupta, ICICI Securities.
13. Pallavi Deshpande, Principal.
14. Komal Iyer, UTI Securities.
15. Viraaj Techchandani, Way2Wealth.
16. Amit Kasat, Motilal Oswal.
Practicing chartered accountants that were interviewed during the process were –
1. Jayant Gokhale, FCA.
2. Mahadeo Bhide, FCA.
3. Dattatray Damle, FCA.
4. Nikhil Damle, ACA.
5. Krupal Kanhere, FCA.
6. Avinash Phadke, FCA.
7. Avani Mehta, ACA.
The bankers that participated in this process to give their views were –
1. Kakodkar, Former Chairman of State Bank of India.
2. Sardesai, Regional General Manager, Bank of Maharashtra.
3. Aamod Tikekar, Manager, Reporting, ABN Amro Central Enterprise
Services.
4. M.N. Sharma, Assistant General Manager, Investment Banking, ICICI
Bank.
5. S.R. Patil, Chairman, Abhudaya Co-operative Bank Limited.

57
To add to this Kiran Deshmukh, COO of Sona Koyo Steering Systems Limited
and Soumya Choudhury, Assistant Vice President of Sona Koyo Steering Systems
Limited contributed their views on the topic and gave some valuable insights
about the stock exchanges in India.
These interviews were helpful to understand the various standpoints of different
classes of investors on the BSE and also the swings created in the market due to
day traders and speculators. The findings and analysis section of this paper shall
clarify the points made herein but there are two schools of thoughts among the
analysts and chartered accountants about the economic progression, accounting
and reporting standards and cross-border listings.
Interviews could have been conducted with a few more people but the time
constraint brought the limitation for which reason this paper makes a
generalisation with the available data.
These interviews were arranged using my industry contacts in the last week of
April 2007 and the first week of May 2007. For this purpose, I travelled to India
in the second half of April 2007 but the appointments were confirmed in March
2007. There are a few other people who did not directly participate in this primary
research, but were of great help in their suggestions and guidance.
This was the method of collecting the data followed during the entire process.
The data was analysed using SPSS for those questions that can be coded, i.e.
allotted numbers such as 1, 2, 3, ….. Most questions being open-ended had to be
read and analysed one by one. Although this is a time consuming process, it helps
in giving better insights about the topic. A detailed discussion of the findings of
this research and their analyses follows in the next chapter of this paper.

58
 4. FINDINGS AND ANALYSIS

Earlier chapter gave details of the way the primary research was conducted.
Meetings with people from different fields related to this research in some way or
the other threw light on the topic in various areas. This chapter gives the facts
brought forth by these people and also the retail investors among whom the
questionnaires were distributed. This chapter gives account of what each
interviewee explained when asked a set of questions. Most interviews took their
own shape once the dialogue was commenced.
This chapter contains the comments of various specialists in these respective areas
whom I met and the findings from the questionnaire survey conducted.
A summarization of the answers obtained from most of the interviewees in the
course of interviews conducted while in India is given in this section. The purpose
of these questions was discussed in the earlier chapter of this paper. These
questions seek to find out the views of these analysts and chartered accountants
on topics such as the volatility of the BSE, the accounting and reporting standards
that Indian companies follow and the flaws or gaps in the procedures, and last but
not the least the investor sentiment with respect to other factors discussed earlier
and their impact on the question of the sustainability of the bull-run on the BSE.

4.1 Volatility and Macro-Economic Variables

When asked about the volatility of the BSE and whether it is a persistent
phenomenon or a temporary one most of the analysts opined that volatility is an

59
inherent part of stock market investing and investors need to keep in mind that
market spins tend to be more pronounced over the short term.

Over the long term, economic and corporate fundamentals matter; they continue
to remain healthy for India relative to most emerging markets. The flip side of the
strong FII flows in recent years is that unlike in the past, Indian markets are now
more integrated with global trends and will be impacted by any contagion, at least
over the near term.

While markets have bounced back after the correction, it is too early to rule out
further volatility over the short term. However, they seemed to be confident of the
prospects of the Indian markets over the medium to longer term. The recent fall in
the Indian markets has come about after a strong rally.

These views contradict the findings of Fung and Lee (1998) who studied the long
term relationships between stocks return on the one hand and GNP, inflation and
money supply on the other in Taiwan and concluded that the efficient market
hypothesis is not valid for an emerging market. Fang and Loo (1995) studied the
relationship between stock return volatility and international trade for four Asian
countries. They however, found evidence in favour of the efficient market
hypothesis.
Bhattacharya and Chakravarty’s (1994) forecasts suggest that the behaviour of
stock price is unrelated to key macro variables. Chaudhuri and Koo’s (2001)
findings indicate that both domestic macroeconomic variables and international
variables have significant impact on stock return volatility. Their results also

60
suggested the role of government in terms of fiscal and monetary policy in
smooth functioning of the stock market is crucial in the Asian region.

4.2 Government Intervention

Apart from the global factors, domestic developments such as sector-specific

measures in the Budget also had an impact on investor sentiment. Also weighing
on the markets could be tightening liquidity, as the RBI looks to stem inflation
through various monetary measures, and the rising risk premium due to the rising
yields in the debt markets. Hence, the recent volatility is not solely due to global
markets.

In India, over the short term, interest rates are likely to exhibit a firm trend, given
the RBI's1 concerns over inflation and high non-food credit off take. The apex
bank has been emphasising the need for a balanced approach wherein India can
witness sustainable growth with price stability. They do not see markets being
impacted by this approach. At this stage, they do not foresee any sharp rise in
rates barring unforeseen circumstances.

When asked about the RBI’s intervention in the capital markets to stabilize them
as does the Federal Reserve, most analysts said that the RBI does not indulge
directly in monitoring and regulating the markets. They added that this is the job
of Securities and Exchange Board of India (SEBI) and the Finance Ministry of the
Government of India and they tackle issues related to stock exchanges. Ravi
Agarwal and Pallavi Deshpande said that the Indian government is looking to FIIs

1
RBI – The Reserve Bank of India is the apex banking institution of India.

61
as a substitute to the FDI investors in India and that is the reason the Finance
Ministry is closely related with these issues. Moreover, they said that the SEBI
has stringent norms on trading, listing and disclosures. This makes the market
quite safe and the information flows more efficiently.

4.3 Impact of Interest Rates

The interest rates are rising in India wherein the prime lending rate has gone up
from 12.75% to 13.25% per annum as on 4th May 2007 as opposed to 10.75% to
11.25% 5th May 2006. The cash reserve ratio has increased from 5% on 5th May
2006 to 6.5% on 4th May 2007. Thus there is an increase of 30% in the cash
reserve ratio. All the interviewees said that this is a temporary phenomenon
brought by the government to control inflation by controlling the money flow in
the economy. They attributed this to the forthcoming general elections in the
country and said that the government has taken this step in desperation to paint a
rosy picture of the success of the ruling UPA government in controlling inflation.

62
 Cash Reserve Ratio and Interest Rates
(per cent per annum)
Item / week 2006 2007
ended
5-May Mar. 30 Apr. 6 Apr. Apr. 20 Apr. 27 4-May
13
1 2 3 4 5 6 7 8
Cash 5 6 6 6 6.25 6.25 6.5
Reserve
Ratio (per
cent)(1)
Bank Rate 6 6 6 6 6 6 6
I.D.B.I.(2) 10.25 10.25 10.25 10.25 10.25 10.25 10.25
Prime 10.75- 12.25- 12.25- 12.50- 12.75- 12.75- 12.75-
Lending 11.25 12.50 13.25 13.25 13.25 13.25 13.25
Rate(3)
Deposit 6.25- 7.50-9.00 7.50-9.00 7.50- 7.50-9.00 7.50-9.00 7.50-9.00
Rate(4) 7.00 9.00
Call
Money
Rate (Low
/ High)(5)
- 4.00/5.95 6.00/80.00 5.25/16.00 1.50- 5.00/20.00 4.00/15.00 5.25/14.00
Borrowings 7.50
- Lendings 4.00/5.95 6.00/80.00 5.25/16.00 1.50- 5.00/20.00 4.00/15.00 5.25/14.00
7.50
(1) Cash Reserve Ratio relates to Scheduled Commercial Banks (excluding Regional Rural Banks).
(2) Minimum Term Lending Rate (MTLR).
(3) Prime Lending Rate relates to five major Banks.
(4) Deposit Rate relates to major Banks for term deposits of more than one year maturity.
(5) Data cover 90-95 per cent of total transactions reported by participants.
Source: Adopted from RBI http://rbidocs.rbi.org.in/rdocs/Wss/DOCs/77404.xls

Commenting on the expectation on interest rate movements in the next one year
and the impact of higher interest rates on the market the analysts said, in general,
that interest rate signals from key global markets such as the US, Japan and
Europe have stabilised, and oil/commodity price rises have also shown stability.
While the debate continues in Japan and Europe, the overall sentiment appears to

63
be bond-friendly. They suggested that it is advisable to wait and see if this trend
continues.

The bankers participating in the interviews added that in India, over the short term,
interest rates are likely to exhibit a firm trend, given the RBI's concerns over
inflation and high non-food credit off take. The RBI has been emphasising the
need for a balanced approach wherein India can witness sustainable growth with
price stability. The analysts do not see markets being impacted by this approach.
At this stage, they do not foresee any sharp rise in rates barring unforeseen
circumstances.

Bordo et al (2006) found that booms ended when monetary policy tightened in
response to rising inflation. A similar situation is found in India with respect to
the tightening of the monetary policy as a measure to control inflation. In India,
prices of primary food articles and manufactured products exerted upward
pressures on headline inflation in 2006-07. Wholesale price inflation was
generally within the Reserve Bank's indicative projections of 5.0-5.5 per cent up
to mid-November 2006 and rose above the upper end of the band thereafter. The
year-on-year (y-o-y) inflation was 5.7 per cent as on March 31, 2007 as compared
with 4.0 per cent a year ago. Measures of consumer price inflation remained
above the WPI inflation throughout the year, mainly reflecting the impact of
higher food prices. The Reserve Bank continued with the policy of gradual
withdrawal of monetary accommodation, using various instruments at its disposal
flexibly to stabilise inflationary expectations, while continuing to pursue the
medium term goal of a ceiling on inflation at 5.0 per cent. The Government also

64
took fiscal and supply-side measures to contain inflation (Price Situations, RBI,
online, 2007, p N/A).

Pagan and Sossounov (2003) explained the theory of Euphoria and Despondency
and also marked that booms arise when interest rates are low/falling and end with
changes in monetary policies. They further noted that there is a negative
correlation between stock prices and inflation.

These factors seem to give rise to doubts about the sustainability of the booms
observed on the BSE. With the tightening of the monetary policy, the disposable
income in the hands of the people becomes less and tendencies of withdrawing
money from risky investments rise.

4.4 Macroeconomic Variables and Investor Sentiment

They also attributed impact of global factors and domestic economic development
on the investor sentiment. They were of the opinion that fashions and fads do
impact the BSE Sensex but less is observed in terms of investing in companies
that adhere to corporate social responsibility. Patil said that since the economy is
growing and investors want to take benefit of the situation to maximize their
wealth, they prefer to invest in companies they think shall deliver them better
earnings irrespective of those companies being socially responsible. Kanhere said
that investors from the developed nations are now looking at these factors but
history does not provide any evidence about those investors investing in
companies that take the cause of corporate social responsibility. Although,

65
Deshmukh gave a different view stating that Indian companies are themselves
turning to the cause of corporate social responsibility and the investors will, in
due course of time follow this fashion.

They added here that these happenings in the stock market have a positive impact
on the investor sentiment. Excessive volatility weakens the investor confidence
but that is limited to day traders. Mahantesh Sabarad of Prabhudas Liladher said
that he is a fundamental analyst and most long term investors go by the
fundamentals to a great extent. Although hedge funds are a culprit to the
projections made considering the fundamental analysis of any given company,
most institutional investors use a mix of the fundamental analysis and the
technical analysis. He added that he termed hedge funds as culprits because their
actions influence the behaviour of day traders who follow the path of hedge funds,
by large, and this in turn has an impact – positive or negative – on the retail
investors. Aniruddha Datta, Viraaj Techchandani, Achala Kanitkar, Huzefa
Suratwala and Bhavesh Dalal conformed what Mahantesh said adding that they
have observed a trend among retail investors to follow the actions of big players
in the market. This action is termed as herding, which they believe to have a
strong grip on the investor’s minds particularly in Indian context. The intra-day
volatility and the daily haphazard movements of the sensex, according to these
analysts, can be related to a great extent to the herding of investors and the bulk
selling or buying by the day-traders. Further they said that the day-traders are a
category who believes in factors which have no base in theory as of today. These
day-traders in Indian stock markets believe in things such as:

66
 • Luck.
• Astrology.
• Blessing of God.
• Superstitions such as buying or selling particular scrip at the beginning of
the day.
• Word of spiritual guru.
They neither take great amount of support of the trend analysis nor the
fundamental analysis to base their calculations on. Another interesting fact about
the day-traders is that they believe certain scrip perform well at particular hour of
the day and act accordingly. These analysts attribute the intra-day volatility to
these day-traders although they said that out of the 250 trading days of the BSE in
a year, the day-traders manage to win on 140 days with their gambles, thus
making sufficient money. But this sends wrong signals through the markets,
mainly picked up by retail investors whose confidence levels fluctuate and has
effect on their behaviour and buying patterns.
It was important to discuss about the intra-day volatility and the volatility of the
BSE in general here because the sensex has been performing with great
fluctuations every day.

67
 SENSEX 23 Arpil 2007 to 22 May 2007

14600
14400
14200
SENSEX

14000 Series1
13800
13600 Series2
13400
13200
13000
8/ 0 7

/5 7
/0 07
7
3/ 07

/0 07
07
00

11 00
0

21 /2 0
20
20

16 /20
2
/2

/2

5/
5/

5/
4

5
/0

/0
23

26

Date

Source: Data Collected from

http://economictimes.indiatimes.com/pageshow/1205979708.cms and tabulated.

In the above graph Series 1 indicates the high and series 2 the low. There is a
considerable difference in the intra-day high and low sensex and the graph shows
an overall variation in the sensex each day. This is termed as a high volatility and
also the difference between the high and low is quite noticeable from this graph
which seems to come closer after 16th of May 2007. This volatility is attributed by
many analysts to the herding effect but they argue that it is the correction that is
taking place in the market on a daily basis.

68
4.5 Random Walk and Efficient Market Hypothesis

This correction can be related to the random walk theory put forth in the literature
review chapter of this paper. The market adjustments are in line with the
observations of Kendall (1953) where molecular movement was studied to get a
hang of the stock markets and stock price behaviour. Chandra’s (2003) findings
also support this phenomenon on the BSE where he goes a step ahead to say that
randomness is the result of an efficient market. Fama (1970 and 1991) concluded
that study on the market efficiency point to the weak form by large. Dimson et al
(1998) opined that semi-strong form of market efficiency can be related to the
correlation among the speed at which information passes through the market and
the time taken to digest it and relate it to fundamentals.
Results from discussions with analysts suggest that the BSE is still in its weak
form of efficiency where information is not always processed as fast as it should
be to make the market semi-strong efficient.
S. Ramnath, Mahantesh Sabarad, Tejas Trivedi, Shilpa Gupta and Komal Iyer
said that money continues to pour in India at a roaring pace through FDI and FII
routes as the consistent and stable growth story seems intact. It seems that the
Bull Run is here to stay with a genuine momentum and may be the euphoria point
is not yet reached. It has almost clearly been understood and realized by Global
Funds, Emerging Market Funds, Asia-Pacific Funds, India Centric Funds and
even the retail investors back home that Indian Capital Markets cannot be ignored
any more if their respective portfolios need value addition. Since the burst of IT
Bubble in 2000, investors have become increasingly reluctant to investments in

69
the stock market. Investors who made risky investments in the past and lost
money have become more and more interested in limiting risk-taking, without
having to abandon the stock market altogether. Institutional investors and fund
managers are therefore facing a new demand - a demand for a tool to analyse
securities which limits the risk of loosing money. Clearly, this opens the
possibility that securities trade at prices that deviate substantially from their ‘fair’
prices. Financial research shows that a number of firm characteristics (e.g., firm
size, value and growth attributes, and past price performance) are useful in
predicting future stock returns. These characteristics are shared by a large number
of stocks, which provides a large pool of stocks to invest in, and reduces the loss
of diversification entailed in trying to exploit the characteristic-based return
predictability.

Sharma and Sardesai said that large and widespread declines in Sensex stocks
have, in recent times, been accompanied by increases in turnover and in the
number of shares traded. It would seem that, under such conditions, bulls lie in
wait, ready to devour the bears.
Some of the analysts drew attention to the fact that the Sensex, Nifty and CNX-
500 fell by 10.5 per cent, 10.75 per cent and 10.8 per cent respectively. But CNX
turnover increased only 6 per cent from a one month average of Rs 99,000 crores
(1 crore = 10 million) a day to a 10-day average of Rs 1,05,000 crore (1 crore =
10 million) per day, while the quantity of shares traded fell marginally from 3.7 to
3.6 billion per day. This suggests that supply is falling short of demand at the
lower prices. There are more people willing to buy than to sell.

70
They further added that this was also true of shares of banks and finance
companies. Their prices have fallen across the board, in many cases sharply. But
in most cases volumes have been thin. Bears do not seem to be in a hurry to allow
bulls to feed on them. Sensex stocks, however, have been treading the beaten
track. Jamshed Dadabhoy added that the average daily turnover and trades over
the ten working days since February 21 stood at Rs 5267crore and 96.4 million
respectively; 40 and 60 percent above those prevailing earlier this year, when the
Sensex was on its way up. Clearly many small and/or institutional holders,
probably the former, who are usually less well-informed and often not as street
smart, are tumbling over themselves to sell, while there is no scarcity of people
willing to lap up these shares as fast as they become available.

Here a point is made about information passage and digestion among the investors.
Further, as the demand is exceeding supply, going by the economic theory of
demand and supply equilibrium prices (Ahuja, 2003, p 317) discussed in the
literature review chapter, the prices shall tend to increase.

4.6 Accounting and Reporting Standards

The chartered accountants interviewed during the process said that there are still
shortcomings in the accounting and reporting standards. They attributed the cause
to the fact that they check the books of accounts of companies based on the
information provided to them by those companies. They consider this as a cause
of worry at some point in time but have not raised a possibility of accounting
scams due to the stringent compliance programmes and guidelines of the Institute

71
of Chartered Accountants of India (ICAI), the governing body of chartered
accountants. The ICAI works in tandem with the Comptroller General of
Accounts and Audits in India to prevent any scams from taking place. Moreover,
they said that the accounting standards issued by the ICAI conform to the US
GAAP that makes it easy for the readers across the borders to understand the
performance of the companies. This discussion came up in view of the general
views of the analysts that FIIs and hedge fund managers invest only after
fundamental analysis of companies.

Prof. Penman (2003 [online], p 77) questioned the performance of US GAAP and
its quality on the backdrop of the accounting scams in the US in 1990s. A number
of failures of GAAP and financial disclosures were identified that, if not
recognised, can promote momentum investing and stock market bubbles. This is
another matter of concern if the ICAI standards are claimed to conform to the US
GAAP then possibility of scams cannot be held distinct which can be unhealthy to
the sustainability of a boom.

When asked about their views over the new regulations the SEBI has introduced
regarding the abridged format of the balance sheet, most chartered accountants
said that this is prescribed in the Companies Act, 1956, section 219 and is
permitted since 1989. They also added that this is an international practice and
legal in India but has certain drawbacks. When asked about the transparency of
the balance sheets, these chartered accountants said that companies can publish
their annual reports online, which the investors can use whenever they want to.
But only problem cited in this is that there are only 40 million internet users in

72
India that forms a very small percentage of penetration. This may cause some
hindrance. They further said that the SEBI has given just one more option but it
depends on the companies whether to exercise it or not and the shareholders shall
decide whether to support this move or to oppose it.

4.7 Corporate Earnings Performance

When asked about the satisfaction with corporate earnings performance in the
third quarter and expected growth rates to be maintained over the next four
quarters the analysts said that third quarter numbers from most companies/sectors
have been either in line with expectations or above estimates. The rise in
borrowing costs can be mitigated to a large extent due to overseas borrowings by
Indian companies, which have de-leveraged their balance sheets to a great extent
by taking advantage of the buoyant equity markets.

The analysts said that the corporate earnings performance has been extremely
high recording a growth of around 30 percent over the last five years which they
did not see as a long lasting phenomenon.

They further added that there could be some short-term volatility due to earnings
expectations - over the last five years earnings growth on an average has been
around 30 per cent, which would not be sustainable going ahead. Typically the
multiplier is not more than 1.5 times the nominal GDP growth and hence, they
could see earnings growth settling at a sustainable rate of 15-20 per cent.

73
Around 82% of the retail investors responded negative to having their own study
and analysis of the corporate earnings performance and also the overall
performance of the companies listed on the BSE. They asserted that they hold on
to mutual funds and hedge funds so that their money lies in safe hands. This gives
a broad picture that the actions of mutual funds and hedge funds managers dictate
the BSE to a great extent. Although the sample size of 194 respondents is not an
enough indicator of the 5 million odd retail investors, this paper analyses their
responses to base the findings staying within the limitations faced for the study.

4.8 Market Direction

Commenting about the projection for the market direction in the near term and
medium term the analysts opined that over the near term, markets could be
impacted by the tightening liquidity as RBI looks to stem inflation through
various monetary measures and the rising risk premium due to the rising yields in
the debt markets.

However, given the strong economic fundamentals, these analysts believe that the
medium- to long-term outlook remains positive. One of India's key advantages is
that it does not rely excessively on external demand as a source of growth.

As a result, India has much better balance in its growth model than the rest of the
Asian region - giving it a built-in macro-resilience that other emerging economies
lack.

74
They further added that this would help Indian markets over the medium to long
term, as investors recognise the underlying strong fundamentals. Any sharp
corrections from these levels can be used to increase exposure to equities.

For retail investors, the best course to follow is to stay focused on the long term,
make disciplined investments in equity funds through the systematic route and to
adhere to a customised asset allocation plan that is tailored to their risk appetite
and financial goals.

For conservative investors, floating rate, short-term income, FMPs and liquid
funds continue to be ideal for the current market conditions.

4.9 Factors Impacting Market Movement

The factors that could potentially pull down the market or hold up its upward
march in the near-to-medium term as cited by these analysts are as under:

First and foremost is the global liquidity situation, which was one of the prime
reasons for the rise in equity markets around the world. One needs to closely
monitor the possible impact of interest rates in the developed economies on the
flows into emerging markets.

Other risks include: energy prices, infrastructural bottlenecks, availability of

skilled professionals, growing current account deficit and reforms becoming a
prisoner of political wrangling.

75
Given the expected robust GDP growth and the relatively higher earnings growth
that corporate India is expected to exhibit compared to comparable economies,
while sentiment could be impacted over the short term due to these risks, they
believe that sound fundamentals will prevail in the end.

4.10 Good Performing Sectors

When asked about the out-performing and under-performing sectors in the market
over the next one year the observation was that over a one-year period there are
many imponderables that could impact the direction of the markets. Hence, it is
important to take a medium- to long-term view while investing in the equity
markets. These analysts suggested that long-term investors are better off adopting
a bottom-up approach and invest in companies with good fundamentals across
market cap ranges and sectors.

Some financial and stock market analysts from India stated in telephonic
conversations that fundamental analysis or DuPont analysis of companies forms a
backbone to future predictions. Ritesh Kejriwal of Motilal Oswal Investment
Group in India is of the clear opinion that present day stock prices depend
strongly on the future expectations of companies as well as the political scenario
and economic conditions. Further, he stated that Indian investors look at
dividends to base their demand for the stocks.

However, they continue to believe that sectors that can piggyback on the domestic
consumption theme such as retail banking, consumer goods and automobiles;

76
trends in domestic infrastructure spending such as construction and capital goods;
and companies benefiting from the outsourcing theme may offer investment
opportunities for long term investors.

Further they added that mid- and small-cap stocks have under-performed the
broad markets in the last year or so, after some years of strong performance.
While this segment is likely to under-perform over the short term, we believe, at
current valuations, fundamentally sound stocks in this segment are likely to
deliver a good performance over the long term.

S. Ramnath, Jamshed Dadabhoy, Achala Kanitkar, Shilpa Gupta, Pallavi

Deshpande and Amit Kasat put certain situations as under:

They say that the market is on roll and expect it to be rising further for at least the
next six months from May 2007. They say that the uncertainty and tentativeness
over the reforms process and policy decisions that had left the market groping for
direction in mid-April have receded to a large extent. Further, they suggest that
the four key economic/corporate trends that have provided the market with the
much-needed impetus will continue to be critical. Of these, the outsourcing boom
in software, pharmaceutical and, to an extent, automobile components, has
provided the thrust to equity prices. The other influencing factors that will
continue to sway market sentiment are:

77
4.10.1 Emerging Global Mindset:

Despite reservations on policy-making under the new Government, Corporate

India went ahead with globalisation plans.

Apart from IT and pharmaceutical, where a global mindset has been taken for
granted, companies from sectors as diverse as steel, non-ferrous metals, chemicals,
automobile components and petroleum have been actively scouting for global
opportunities in the last five months.

For instance, Tata Steel's acquisition of NatSteel, Singapore, for $486 million
reflects a trend followed by others such as Mahindra & Mahindra and GAIL on
the global acquisition path. Moreover, they drew attention to Tata Steel’s recent
acquisition of Corus and many other cross-border acquisitions of Indian
companies. Amit Kasat and Pramod Amthe said that successful mergers and
acquisitions shall act as an instrument to diversify the risks for Indian companies,
which will help in keeping the investor confidence at a high level.

To a large extent, this is a continuation of the activity initiated in 2003 by Tata

Motors, Sundram Fasteners and Bharat Forge, which completed overseas
acquisitions. This trend is likely to gather further momentum with every passing
month.

Moreover, all the interviewees drew attention to the fact that retail investors form
only a minor segment of the total investments on the BSE and thus analysts are
not much worried about the moves from these investors. The big fish that matter

78
are the Foreign Institutional Investors (FIIs) and the foreign hedge funds. All the
interviewees asserted the fact that foreign hedge funds increase the risk exposure
of the BSE but said that they are not much worried as there are no near
competitors to the Indian stock exchanges in the Asian region. Moreover, India
Inc. being a growth economy with a stable government having liberal business
policies seems to be a hot spot for foreign hedge funds for at least two to three
more years.

4.10.2 Infrastructure Drive:

The UPA Government started off on a wrong note vis-à-vis infrastructure policy-
making. The muddle over the review of the Electricity Act, 2003 and the question
of bridging the fiscal deficit without privatisation dented the equity market. But
over the past few years, intense efforts have been made by the government to
restore confidence on the infrastructure front.

Several steps have been taken to address this issue. These include the approval of
investments under the automatic route, the setting up of the Investment
Commission and a Cabinet Committee on Infrastructure headed by the Prime
Minister, Dr Manmohan Singh. The Finance Minister, Mr P. Chidambaram,
addressing the India Investment Forum on his visit to New York, said the
infrastructure problem can be tackled by attracting large sums as Foreign Direct
Investment in such areas as power and telecom.

79
The Planning Commission Deputy Chairman, Dr Montek Singh Ahluwalia, also
pitched in by talking about using, say, $5 billion a year out of $120 billion of
forex reserves over the next two to three years, for improving the quality of
infrastructure.

Shyam Agarwal, Ravi Agarwal, Jayant Gokhale and Avinash Phadke seemed to
be strongly positive about the government initiatives and drew attention to the
Essar Telecom’s merger deal with Vodafone. They see this as a move to restoring
investor confidence in the telecom sector. Also, Ajeet Garde1 said in a telephonic
conversation that Tata Indicom, the telecom wing of Tatas bought VSNL (Videsh
Sanchar Nigam Limited) the telecom and internet service provider owned by the
government of India, which enabled to increase the levels of service and boost
profits. This gave stability to the mergers and acquisitions situation and also a
contender to counter the buy outs of Indian telecom companies by foreign
companies or multinationals.

4.11 Analysis of the Stock Markets

Kakodkar referred to the five-in-a-row loss of the Australian cricket team to New
Zealand and England and commented further that “the bigger they are, the harder
they fall”. He was making a point about the BSE sensex growing enormously
which he feels is above average and beyond forecasts. He related it to simple
fundamental performance of the companies in question while talking about the
BSE Sensex.

1
Ajeet V. Garde is the CFO of Tata Cummins Limited.

80
Huzefa Suratwala said that the market fell before the presentation of the Union
Budget that started on 27th February 2007. He made it clear that the sensex fell off
its own weight and not because of any other external factors. His view conforms
to the findings of Bhattacharya and Chakravarty (1994) that the behaviour of
stock prices is unrelated to key macro variables but strongly contradicts later
findings of Chaudhari and Koo (2001) who found that domestic macroeconomic
variables and international variables have significant impact on stock return
volatility. Their results also suggested the role of government in terms of fiscal
and monetary policy in smooth functioning of the stock market that is crucial in
the Asian emerging economies’ region. To an extent, there is evidence of
governmental role in Suratwala’s comments pertaining to the BSE.
Almost 87% of the retail investors responded positive of relying on trend analysis
of the markets to base their investing decisions on. Chandra (2003, p 409) says
that technical analysts analyse internal market data with the help of charts and
graphs. They look at charts to understand what the market participants have been
doing and believe that this provides a basis for predicting future behaviour.
According to Fama (1970) this can be related to weak form market efficiency that
studies the past trends to base its future expectations on.

These ways are strongly contradicting to Warren Buffett’s ways wherein he

suggests that invest in businesses and look to the future by analysing the
performance of the companies Hagstrom (1994, p 132).

Further, there was a strong correlation found between influence of friends and
relatives in investing decisions of individual investors. This can be termed as

81
herding to an extent and exactly resembles the observations of East (1993).
Morris’s (1996) findings suggest that a speculative premium occurs as each trader
anticipates the possibility of reselling the asset to another trader before complete
learning has occurred. Nagy (1994) argues that individuals base their stock
purchase decisions on classical wealth-maximization criteria combined with
diverse other variables. They do not tend to rely on a single integrated approach.

Moreover, the introduction of the AIG India Fund and the J.P.Morgan India Fund
in the Indian market makes investors go to them. Tushar Pradhan of AIG said that
they do not rely on one fund manager but they have a team approach and believe
that Indian economy is performing well which makes it profitable for them to
invest in this economy. He also said that they carry a brand name that boosts
confidence levels among the retail investors. When asked about the J.P.Morgan
India Fund, Tushar said they are a strong competitor but healthy one as it is not a
race of attracting investors in the Indian market that has almost 5 to 6 million
retail investors and this figure is expected to grow by at least 15 to 17 percent
over the next two years. He added that with J.P.Morgan in the race, the equities
markets in India will experience a boom due to aggressive buying and investing
strategies followed by these two companies.

Tushar further believes that it is the job of professional fund managers to calculate
the risk and expected return on investments and advise their clients on the most
profitable options available. He did not see any need for the investors to be highly
knowledgeable in the field of investments.

82
The questionnaire was designed to ascertain the level of knowledge of retail
investors that yielded a result of mediocre knowledge among retail investors that
needs to be enhanced. Pramod Amthe of ABN Amro Securities said that retail
investors need to enhance their knowledge about the stock markets so that the
hedge fund managers will have to be on their toes at all times that will make the
market more competitive. He also suggested that this will lower the effect of
speculators and herding shall come down. If the investors are more
knowledgeable about the stock markets, the market may move towards being
more semi-strong efficient as described by Fama (1970) and Chandra (2003).

4.12 Information
A few analysts and chartered accountants including Tikekar from ABN Amro
Central Enterprise Services said that one of the prerequisites for trading success is
to have the ability to anticipate and take quick decisive action. Most of the traders
become unstuck in the market because of their inability to identify a change in
trend well in time. The fallout of this is that by the time they come to grips with
the fact there has been a change in trend, it is probably too late in the day to close
out their existing positions, leave alone reverse them.
When asked about the ways these traders can universally apply these people said
that there is no short cut to hard work. Traders would do well to note the
following if they are serious about succeeding while trading:
• Never trade unless sure of the trend. When in doubt, get out.
• Spend as much time as is possible in studying and preparation.
• Spend little or no time in front of a trading screen.

83
 • Employ strict money management rules.
• Be quick to take losses.
• Keep good records.

They further added that an interesting point to note about the current fall in the
market was that the Indian markets turned nearly two weeks before the bear
contagion engulfed the world markets in the last week of February.

Perhaps the rest of the world will start tracking the Nifty more closely now for
omniscient signals.

The analysts also said that investors act on the publicly available information but
the contamination of this information due to herding effect poses a threat to the
true and fair valuation of the stocks traded on the BSE and the NSE.

Amit Wagle said in a telephonic conversation on 23rd May 2007 that share prices
were driven higher by sustained purchases by Foreign Institutional Investors (FIIs)
and domestic funds in the past few days and today's slide was seen as a necessary
correction for the market's sound health.

Asian markets exhibited steady to mixed trend during the day, having a
sentimental impact on the bourses.

Ramnath, Techchandani, Amthe, Kanitkar, Shyam Agarwal and Dadabhoy said

that fads and fashions do not influence the investing patterns of the investors in
the Indian stock markets. This is contrary to Rosen et al (1991) findings that

84
suggest emergence of individual and institutional investors being inclined towards
investing in companies that take up the cause of corporate social responsibility.

Mahantesh said that investors are aiming at companies such as Reliance Energy
and Reliance Petrochemicals that are in controversy over the acquisition of lands
of farmers in the Gujarat state in Western India at lower than market prices. But
investors feel that energy sector has good growth prospective over the next decade
looking at the overall economic growth of India and the prevailing shortage of
energy – mainly electricity in India. This behaviour contradicts the findings of
Rosen et al (1991) and Shiller (1990). But Shiller’s (1990) findings that fashions
and fads can contaminate stock prices seems to hold good in the case of the BSE
as with certain comments from experts and the government officials about the
energy sector, investors have shown a keen interest in investing in these sectors.

This behaviour can again be linked to herding (Oliver, 2002) and also “building
the castles in the air” as described by Chandra (2003). Investors know little or
nothing about these companies as they are relatively new and the future is
predicted with this little or no knowledge. This can be linked to the happenings of
the Mississippi scheme or the South Sea Bubble. The Internet bubble also
provides an example of a similar situation when investors knew very little about
the nature of businesses to project the future cash flows but money was poured in
these businesses, which created a bubble.

85
 5. CONCLUSION AND RECOMMENDATIONS
5.1 Conclusion
The Mississippi Scheme discussed in this paper threw light on the facts such as
investors believe in strong statements by the promoter/s, sense signals within the
market and determine their demand based on what they expect to earn in the
future. Many analysts interviewed during the primary research process said that
almost 50 to 55 percent of the shareholding in India is among the promoters. This
can cause an effect such as that in the Mississippi scheme in the future. The only
difference is that the investors in the Mississippi Scheme had no choice but to
believe the promoters’ statements due to lack of accounting or forecasting laws.
Now we have various accounting and reporting standards in place that make it
mandatory for the companies and their promoters to give a true and fair picture of
the performance of the companies.
The South Sea Bubble was again due to a rosy picture painted of the future
earnings by the governors of the company, which led to herding and high future
expectations among the investors. The crash of the share prices of the South Sea
Company can be attributed to the political adversaries among Great Britain and
the Spanish king that made future earnings very low.
Tulipomania was the result of unjustified demand for the tulip bulbs in Holland
that created adverse equilibrium price. This can be said as the pricing of luxury
goods that takes place to maintain or show status among the society by the buyers
(Naik, 1991, p 263).
The 1987 crash of the NYSE is also attributed to the herding and higher future
expectations among the investors. The SEC had done its job of educating the

86
investors in the post-war era but it could not make the investors think. Sahuraja
(2003, p 314-356) says that infatuation among the investors led to the crash of
19th October 1987 of the NYSE’s Dow Jones Industrial Index. The Internet
bubble of 2000 was a result of super normal future expected earnings of
companies that did not exist or had not even completed one year of business. But
people thought that internet was the mantra of the new era – the new economy.
This created situations similar to the South Sea Bubble and Tulipomania, which
was actually a bubble in reality. The bubble burst in 2000 and that was a shock to
many investors who had invested in the IT companies then.
These bubbles were a result of high investor confidence and strong investor
sentiment. Barberis et al (1998), De Long et al (1990) and Lee et al (1991) say
that investor sentiment, in part, is unpredictable. The authors say that the investors
observe earnings, and use this information to update their beliefs about which
state they are in. Daniel (1998) and Abarbanel (1992) stressed on overreaction
and under reaction among the investors and security analysts. It was observed that
the Indian markets sway, to a great extent, depending on the statements and
analyses published. Investors in this region are believed to be risk averse, by large,
and follow the directions provided to them in some way of the other. This
behaviour can be termed herding and attributed to the limited knowledge of the
market.
Sahuraja (2003, p 314-356) explained the concepts of euphoria and despondency
while Lee (2006, online, p N/A) opined that major bull markets start when
investors are feeling depressed and bear markets start when they are feeling
euphoric.

87
 SENSEX 1998-99 TO 2006-07

16000
14000
12000
10000
8000 Series1
6000
4000
2000
0
4 /6 /1 9 9 8

4 /6 /1 9 9 9

4 /6 /2 0 0 0

4 /6 /2 0 0 1

4 /6 /2 0 0 2

4 /6 /2 0 0 3

4 /6 /2 0 0 4

4 /6 /2 0 0 5

4 /6 /2 0 0 6

Source: Data collected from bseindia and tabulated.

There is a steady increase in the BSE Sensex from 1998-99 to 2006-07. This gives
a picture that the investor confidence is high and that the investors have not yet
reached the stage of euphoria. Although there are downfalls in the BSE Sensex
from time to time, many analysts held these as corrections within the market and
did not see this as a point from where the market can slide down over a long
period nor suspected a crash.
These movements can also be attributed to the random walk theory and the
market efficiency. Chandra (2003, p 270) has termed these movements in the
stock prices as random walk. He further claims that the randomness of stock

88
prices was the result of an efficient market. Fama (1970) suggested three levels of
market efficiency – weak-form efficiency, semi-strong form efficiency and strong
form efficiency. He further stated that market behaviour is an important aspect in
stock prices, returns and eventually the stock market indices.
In the efficiency context Dr. Oliver (2002, online, p 1) said that it is not that when
investors are confident, prices rise and when investors are not confident, they fall.
He pointed that individuals are less than perfectly rational and that they behave as
a crowd – herding effect.
A similar situation exists on the BSE as most investors prefer to follow bigger
investors or rely on some acquaintance that they think has a better understanding
of the markets. Investors follow these self benchmarked people or their advice
which creates a question about the efficiency of the BSE. Another interesting fact
is that retail investors on the BSE prefer to invest their money in mutual funds
whereby these mutual funds grow. Many hedge fund companies have their India
funds operating which analysts say is due to the macro-economic growth of India
and the forecasts about the growth in the next decade. This is again a matter of
concern as political stability and relations with neighbouring countries will have a
great impact on sustaining the economic growth of India. Further, India is a
victim to global terrorist activities which can pose a threat to sustained economic
growth. Since its independence in 1947, India fought several wars with its
neighbours – Pakistan and China. India and Pakistan fought wars in 1947, 1965,
1971 and 1999 while India had border skirmishes with China in 1962. Moreover,
there are active communist rebel groups in parts of India and also infiltration from
the Jammu and Kashmir state in northern India. The effect of terrorism was felt in

89
Mumbai on 12th March 1992 when the terrorists managed to blow up the BSE
building. The last horrendous attack India saw was that of the Parliament being
attacked in December 2001. These are issues to be worried about and analysts
said that hedge funds are highly mobile – they may shift to some other countries if
they feel the Indian scenario is not conducive to invest their money in.
Jawle (2005) stressed on the growing middle-class effect in India and gave one of
the reasons for the increasing role of mutual funds. His observations match the
primary research conducted that suggests retail investors’ preference of mutual
fund investments. Analysts said that the 5 million odd retail investors constitute 2-
3 percent of the total investments effected on the BSE. Thus there is a chance of
growth in the retail investors as 5 million is a very small part of the 1.2 billion
population of India. Mumbai alone has a population of nearly 20 million.
Hagstrom (1994, p 132) described the investment strategies of Warren Buffett
where he says that do not worry about the economy and buy a business not a stock.
This can be done only if the investor has large amounts of money to invest. But
this holds good in the case of fund managers. If these fund managers go by the
way of Warren Buffett, probably there will be no risk of these hedge funds
leaving the country and the stock market crashing.
Another important issue here is the knowledge of the investors and their ability to
read and understand the financial statements published. The primary research
revealed that Indian investors, by large, lack the knowledge and understanding
required in reading and digesting the information contained in the financial
statements.

90
In reality, we can sum up, that people create most of the risk in the market place
by inflating stock prices beyond the value of the underlying company. When the
stocks are flying through the stratosphere like rockets, it is usually a sign of a
bubble. That is not to say that stocks cannot legitimately enjoy a huge leap in
value, but this leap should be justified by the prospects of the underlying
companies, not just by a mass of investors following each other. The unreasonable
belief in the possibility of getting rich quick is the primary reason people get burnt
by market crashes. This moves in the direction of the rule of thumb – higher the
return higher is the risk. Another observation is that regardless of our measures to
correct the problems, the time between crashes has decreased. We had centuries
between fiascoes, then decades, then years. It is difficult to say whether this
foretells anything dire for the future, but the best thing one can do is keep updated
and educated, informed and well-practiced in doing research. From the primary
research conducted it is clear that the confidence of the analysts and brokers is
high and since this is a factor that is impacting retail investors’ decisions, the BSE
Sensex can keep its stride upwards, approximately, for the next two years.
Herding effect that is high on this market will help in keeping the market high and
also the entry of hedge funds in India looking at the economic growth suggests the
same. Measures need to be taken in retaining the interest of hedge funds in the
Indian monetary markets and the bull-run will take care of itself.

91
5.2 Recommendations

Stop building castles in the air

As discussed in the findings and analysis chapter of this paper, there is a tendency
found among the investors to invest in energy sector within the Indian markets.
But most investments are in companies that have a very short history of energy
production and distribution. This seems to be a threat in terms of future expected
earnings.

Diversify the portfolio

A well-diversified portfolio of investments hedges the risk carried by some scrip
as opposed to others. Portfolios can be risky but the risk should be calculated and
hedged by certain scrip in the portfolio. Investors should not invest in risky
options only.

Invest in businesses
There are many investors who believe in short-term gains and therefore prefer
day-trading or very short-term trading. This increases the volatility of the markets
and creates chance for a panic in the short-run. Moreover, the hedge funds that
constitute the major players in the BSE seem to invest in the economy not the
businesses. The analysts said that foreign hedge funds are coming to India as the
economy is growing and is expected to perform positive for the next decade or so.
Moreover, Jawale’s (2005) findings suggested the increasing effect of middle
class on the growth of mutual funds in India which is an indicator that there will
be increase in the number of hedge funds within India. But if these fund managers

92
continue to invest in the direction of the swing in the economy, these investments
will be vulnerable and exposed to crash in the future. If the fund managers start
investing in businesses, the businesses will grow and lead to a growth of the
economy. This will help in meeting both ends for the fund managers and the
market will sustain the bull-run for quite a long period of time.

Enhance knowledge of the investors

Enhancing knowledge of the retail investors will enable them to analyse the
situations by themselves and take near to correct decisions. This will help in
minimizing their dependence on analysts and brokers to advice them. Also the
investors will be in a better position to calculate the risks involved in investing in
hedge funds and can restore the balance of the market. Further, it was stated that
there exists a tremendous imitation and herding effect among the retail investors
in the BSE. With enhanced knowledge this effect will gradually lower making the
markets more stable. There can be lesser situations of panic and over-confidence.
This can lead to greater levels of corrections for certain time period but will help
in stabilizing the market. This would mean lesser risk and would be a beneficial
situation for the companies listed, retail and institutional investors and the
government.

Make media accountable

There exists a great contribution of the media in swaying the investor sentiment in
the Indian context. The media should be made accountable to what they publish
so that the publications do not result in overreaction or under reaction that can

93
sway the markets unnaturally. Many respondents to the questionnaires that were
distributed among retail investors said that they take assistance from the published
articles and television news to decide on their investments. This makes it
necessary to make the media accountable for the matter they publish and their
forecasts.

Make annual reports more reader friendly

Annual reports of the companies are prepared in accordance with the Indian
Companies Act, 1956. There is a room to make these annual reports more reader
friendly as some of the terms used can only be understood by esoteric readers
only. This needs to be simplified and published in a manner which all the users of
the annual reports can understand. The financial reports of the companies in India
are published every quarter in a year but the common problem is that most
investors only understand the profit and loss account and balance sheet. The real
tool to understanding financial reports is the cash flow statement as it gives a true
and fair picture of the company’s performance. Companies must take the cause of
educating the users of the financial reports so that they interpret the performance
of these companies correctly.

Involve the entire cabinet in smooth functioning of the stock markets

Presently the Finance Ministry is entrusted with the job of ensuring the smooth
functioning of the stock markets in India. This job must be shared by the entire
cabinet of ministers so that an all round care is taken of the stock markets. The
Ministry of Foreign Affairs should ensure that the country is maintaining good

94
relations with other countries and especially the neighbouring countries so that
there is no threat to border skirmishes. This will help in mobilizing funds towards
the economic development of the nation. Similarly, every ministry can have its
own role to play in stabilizing the economy which will lead to flourishing of
businesses and this in turn will leave a less volatile market.

5.3 Limitations and Scope for Further Research

Due to time constraint fundamental analysis of the BSE 30 companies that form
the sensex could not be undertaken. Such an analysis would have given
robustness to the findings and recommendations would have been supported with
figures. Another problem faced was that time constraint and data protection and
leakage prevention norms of organisations forbade from meeting many retail
investors working in organisations among whom the questionnaires were
distributed. With ample time this study could have taken into account the daily
movements of the stock prices and the changes therein, to calculate the exact
volatility and check it against the US markets to see if the BSE can sustain the
bull-run to reach the market capitalization mark of the American stock exchanges.
Moreover, a daily study of stock price movements would have been helpful in
ascertaining the impact that day-traders leave on the BSE and a relationship could
have been developed to give robust results for the herding effect persistent among
the retail investors.
There is an avenue to conduct this research in depth following the daily and
hourly movements of the BSE Sensex to understand the investor sentiment with
every minute change or change in investor sentiment that brings about change in

95
the BSE Sensex. This can be done by laboratory experiment on a well-defined
group of investors. Further, the study can be related to cultural differences and
sustainability of the growth of the stock market index. These being a behavioural
part of finance that studies human behaviour; it becomes difficult to come up with
concrete conclusions as the same human being may behave differently in different
situations or at different times.

96
 6. BIBLIOGRAPHY

ABARBANELL, J. & BERNARD, V., 1992. Tests of Analysts’

Overreaction/Under reaction to Earnings Information as an Explanation for
Anamolous Stock Price Behaviour. The Journal of Finance, 4 (3), 1181-1207.
AHUJA, 2003. Modern Economics. New Delhi: Sultanchand.
AJZEN, I., 1991. The Theory of Planned Behavior. Journal of Organizational
behavior and human decision processes, 50, 179-211
AKERLOF, G. & YELLEN, J., 1987. Rational Models of Irrational Behaviour in
the Contribution of After 50 Years. The American Economic Review, 77 (2), 137-
142.
ALPERT, B., 1997. Mind Bender: How Three Economists Profit on Frailities of
the Human Brain. Journal of Behavioural Finance, 77, 21-21.
BACHELIER, L., 1964. Theory of Speculation. London: Pearson.
BALL, R. & BROWN, P., 1968. An Empirical Evaluation of Accounting Income
Numbers. Journal of Accounting Research, 6, 159-178.
BARBERIS, N., SHLEIFER, A. & VISHNY, R., 1998. A Model of Investor
Sentiment. Journal of Financial Economics, 49, 307-343.
BEBCHUK, L., & ROE, M., 1999.A Theory of Path Dependence in Corporate
Ownership and Governance. Stanford Law Review 52 (1999): 127–70.
BERTONI, A., BERTNETTI, G., & CESARI, C., 2005. Mutual-Fund
Benchmarking and Market Bubbles: A Behavioural Approach. Transition Studies
Review [online], 12(1). Available from:

97
http://www.springerlink.com/content/p2w1k78875172171/ [Accessed 12 March
2007].
BHATTACHARYA, B. & CHAKRAVARTY, S., 1994. Share Price Behaviour in
India: An Econometric Analysis, ed. Econometric Conference, Pune.
BORDO, M., 2003. When Bubbles Burst. Available from:
http://www.internationalmonetaryfund.com/external/pubs/ft/weo/2003/01/pdf/cha
pter2.pdf [Accessed 1st March 2007].
BORDO, M., DUEKER, M. & WHEELOCK, D., 2006. Monetary Policy and
Stock Market Booms and Busts in the 20th Century. The Journal of Finance, 4 (1),
11-99.
BOUCHAUD, J., & CONT, R., 1998. A Langevin approach to stock market
fluctuations and crashes. The European Physical Journal [online], 6(4) Available
from: http://www.springerlink.com/content/nadxnt88xpv0g4fc/ [Accessed 12
March 2007].
BRADSHAW, M., BUSHEE, B., & MILLER, G., 2002. Accounting Choice,
Home Bias, and U.S. Investment in Non-U.S. Firms. Working Paper, Harvard
Business School.
BROCK, H., 1995. The Future of Behavioural Finance: A Synthesis of
Disciplines. Journal of Investment Management and Research, 52-62.
BSE CROSSES TRILLION DOLLAR MARK, 2007 [online]. Available from:
http://www.indiaprwire.com/businessnews/20070528/22678.htm [Accessed 28
May 2007].
BURR, B., 1997. More Light Shining on the Whys of Investing. Pensions and
Investments, 25 (11), 32-34.

98
BUSHMAN, R., & SMITH, A., 2001. Financial Accounting Information and
Corporate Governance. Journal of Accounting and Economics 32, 237–334.
CHANDRA, P., 2003. Investment Analysis and Portfolio Management. New
Delhi: Tata McGraw-Hill.
CHAUDHARI, K. & KOO, 2001. Volatility of Stock Return: Importance of
Economic Fundamentals. Economic and Political Weekly, 3852-3856.
CHEN, N., 1991. Financial Investment Opportunities and the Macro Economy.
Journal of Finance, 529-554.
DALAL. S., 2003. Who Moved the Bombay Stock Exchange? Mumbai: Aparna.
DAMODARAN, 2004. The Behavioural Part of Indian Stock Markets. The
Economic Times, Saturday 27th March, 16-17.
DANIEL, K. & TITMAN, S., 1999. Market Efficiency in an Irrational World.
Financial Analysts Journal, November/December 1999, p 28-40.
DANIEL, K., HIRSHLEIFER, D. & SUBRAHMANAYAM, A., 1998. Investor
Psychology and Security Market Under- and Overreactions. The Journal of
Finance, LIII (6), 1839-1885.
DEBONDT, W. & THALER, R., 1990. Does the Stock Market Overreact?
Journal of Finance, 40 (3), 793-805.
DELONG, B. & SHLEIFER, A., 1991. The Stock Market Bubble of 1929:
Evidence from Closed-End Mutual Funds. Journal of Economic History, 51 (3),
675-700.
DELONG, J., SCHLEIFER, A., SUMMERS, L. & WALDMANN, R., 1990.
Noise Trader Risk in Financial Markets. Journal of Political Economy, 98, 703-
738.

99
DEMIRGUC-KUNT, A. & LEVINE, R., 1996. Stock Market Development and
Financial Intermediaries: Stylized Facts. World Bank Economic Review, 19 (2),
291-322.
DEMIRGUC-KUNT, A. & MAKSIMOVIC, V., 1998. Law, Finance and Firm
Growth. Journal of Finance, 53, 2107-2137.
DIMSON, E., MUSSAVIAN, M., 1998. A Brief History of Market Efficiency.
European Financial Management, 4 (1), p 91-193.
DREMAN, D., 1998. Contration Investment Strategies: The Next Generation.
New York: Simon Schister.
EAST, R., 1993. Investment Decisions and the Theory of Planned Behaviour.
Journal of Economic Psychology, 14 (2), 337-375.
ECONOMIC TIMES, 2007. Stock Indices [online]. Available from:
http://economictimes.indiatimes.com/pageshow/1205979708.cms [Accessed 28th
May 2007].
FAMA , E., & FRENCH, K., 1992. The Cross-Section of Expected Stock Returns.
Journal of Finance, 47 (2), p 427-465.
FAMA, E. & FRENCH, K., 1989. Business Conditions and Expected Returns on
Stocks and Bonds. Journal of Financial Economics, 25, 23-39.
FAMA, E., & GIBBONS, M., 1982. Inflation, Real Returns and Capital
Investments. Journal of Monetary Economics, 9, 297-323.
FAMA, E., 1965. The Behaviour of Stock Market Prices. Journal of Business, 38,
34-105.
FAMA, E., 1970. Efficient Capital Markets: A Review of Theory and Empirical
Work. Journal of Finance, 25, 383-417.

100
FAMA, E., 1981. Stock returns, Real Activity, Inflation and Money. American
Economic Review, 71, 545-564.
FAMA, E., 1991. Efficient Markets: II. Journal of Finance, 46, 1575-1617.
FAMA, E., FISHER, L., JENSEN, M. & ROLL, R., 1969. The Adjustment of
Stock Prices to New Information. International Economic Review, 10, 1-21.
FANG, H. & LOO, J., 1994. Dollar Value and Stock Returns. International
Review of Economics and Finance, 3 (2), 222-231.
FISHER, I., 1930. The Stock Market Crash and After. New York: Macmillan.
FISHER, K., & STATMAN, M., 2002. Bubble Expectations. The Journal of
Wealth Management, p 17-22.
FUNG, H. & LEE, 1990. Stock Market and Economic Activities: A Causal
Analysis. In RHEE, S. & CHANG, R., eds. Pacific-Basin Capital Markets. North
Holland: Elsevier Science, 497-523.
GALANT, D., 1995. Financial follies: Behavioural Finance. Institutional
Investor, 29, 139-140.
GAN, J., 2004. The Real Effects of Asset Market Bubbles: Loan-and Firm-Level
Evidence of a Lending Channel [online]. Thesis (Ph.D.). Hong Kong University
of Science and Technology. Available from:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=674482 [Accessed 17th March
2007].
GLASS, G., 1976 [online]. Primary, Secondary and Meta-Analysis of Research.
Educational Researcher, 5 (10), p 3 – 8.
HAGSTROM, R., 1994. The Warren Buffet Way: Investment Strategies of the
World’s Greatest Investor. New York: John Wiley & Sons.

101
HANSMANN, H., AND R. KRAAKMAN, 2001. The End of History for
Corporate Law. Georgetown Law Journal, 89 439–68.
HERITAGE, 2007 [online]. Available from:
http://www.bseindia.com/about/Heritage.asp [Accessed 28 May 2007].
HIRIAM H., 2000. The Stock Market’s Glory Days are Over, At Least For Now.
The Philadelphia Inquirer. December 31, 2000 Sunday D Edition,. C01
HOPPE, H., 1992. The Misesian Case Against Keynes. Dissent on Keynes, A
Critical Appraisal of Economics [online], 199-223. Available from:
http://www.mises.org/etexts/hoppekeynes.pdf [Accessed 1 April 2007].
JAWALE, A., 2005. The Future of Mutual Funds in India. Dissertation
M.B.A.(Finance). University of Wales.
KAROLYI, G., 1998. Why Do Companies List Shares Abroad? A Survey of the
Evidence and Its Managerial Implications. Financial Markets, Institutions &
Instruments 7, 1–60.
KASHATRIYA, D., & PATEL, M., 2003. Globalisation and the Asian
Economies: Revamping the Accounting Standards. Mumbai: Taxman.
KENDALL, M., 1953. The Analysis of Economic Time Series. Journal of the
Royal Statistical Society, Series A, 96, 11-25.
KEYNES, J., 1936. The General Theory of Employment, Interest and Money,
New Delhi: Tata McGrawHill.
KHANNA, T., KOGAN. J., & PALEPU, K. Globalization and Corporate
Governance Convergence? A Cross-Country Analysis. Working paper, Harvard
Business School, 2002.

102
KHANNA, T., PALEPU, K., & SRINIVASAN, S., 2003. Disclosure Practices of
Foreign Companies Interacting with U.S. Markets. Journal of Accounting
Research, 42(2), 475 - 508.
KUWAIT’S BULL RUN TO CONTINUE [online], 2004. Available from:
http://www.ameinfo.com/35203.html [Accessed 12 March 2007].
LANG, M., RAEDY, J., & YETMAN, M., 2003. How Representative Are Cross-
Listed Firms? An Analysis of Firm Performance and Accounting Quality. Journal
of Accounting Research 41, 363–96.
LEE, C., SHLEIFER, A. & THALER, R., 1991. Investor Sentiment and the
Closed-end Fund Puzzle. Journal of Finance, 46, 75-110.
LEE, T., BAO, Y. & SALTOGLU, B., 2006. Evaluating Predictive Performance
of Value-at-Risk Models in Emerging Markets: A Reality Check. Journal of
Forecasting, 25 (2), 101-128.
LEIJONHUFVUD, A., 1966. On Keunesian Economics and the Economics of
Keynes. England: Oxford University Press.
LEVINE, R., 1991. Stock Markets, Growth and Tax Policy. Journal of Finance,
46 (4), 1445-1465.
LIU, Q., SONG, F., 2001. The Rise and Fall of Internet Stocks: Should Financial
LO, A., 2004. The Adaptive Markets Hypothesis: Market Efficiency from an
Evolutionary Perspective. Journal of Portfolio Management [online]. Available
from: http://web.mit.edu/alo/www/Papers/JPM2004.pdf [Accessed 28 March
2007].
LYNCH, P., 1990. One Up on Wall Street, New York: Pengiun

103
MACDONALD, R. & POWER, D., 1991. Persistence in UK Stock Market
Returns: An Aggregated and Disaggregated Perspective. In: TAYLOR, M., ed.
Money and Financial Markets, Basil Blackwell.
MACKAY, C., 1982. Memoirs of Extraordinary Popular Delusions. London:
Bentley.
MALKIEL, B., 2002. Remaking the Market: The Great Wall Street? Wall Street
Journal, 16.
MCGRATTON, E. & PRESCOTT, E., 2004. The 1929 Stock Market: Irving
Fisher Was Right. International Economic Review, 45 (4), 991-1009.
MISHKIN, F. & WHITE, E., 2003. U.S. Stock Market Crashes and Their
Aftermath: Implications for Monetary Policy. In: HUNTER, W., KAUFMAN, G.
& POMERLANO, M., eds. Asset Price Bubbles: The Implications for Monetary,
Regulatory and International Policies. Cambridge, MA: The MIT Press, 53-80.
MORRIS, S., 1996. Speculative Investor Behaviour and Learning. The Quarterly
Journal of Economics, 111 (4), 1111-1133.
NAGY, R. & OBENBERGER, R., 1994. Factors Influencing Individual Investor
Behaviour. Financial Analysts Journal, 50 (4), 63-68.
NAIK, S., 1991. Fundamentals of Economics. Mumbai: Vikas.
NAIR, A., 2004. Higher the Risk Higher the Return – A Case Study of the NSE of
India. Dissertation (M.B.A.). Indian Institute of Management, Ahmedabad.
NAJ, M. & RAHMAN, H., 1991. Stock Market Volatility and Macroeconomic
Variables: International Evidence. Journal of Multinational Financial
Management, 1 (3), 51-56.

104
NEUMARK, D., TINSLEY, P. & TOSINI, S., 1991. After-hours Stock
Prices and Post-crash Hangovers. The Journal of Finance, 46 (1), 159-178.
O’BRIEN, P., & TIAN, Y., 2006 [online]. Financial Analysts’ Role in the 1996-
2000 Internet Bubble. Available from:
http://www.papers.ssrn.com/sol3/papers.cfm?abstract_id=964311 [Accessed 7
March 2007].
OLIVER, J., 2002. The Changing Structure of Corporate Canada and Canadian
Capital Markets. Canadian Public Policy, 27 (2), 219-233.
OSLEN, R., 1996. Implications of Herding Behaviour for Earnings Estimation,
Risk Assessment and Stock Returns. Financial Analysts Journal, 52 (4), 37-41.
PAGAN, A. & SOSSOUNOV, K., 2003. A Simple Framework for Analysing
Bull and Bear Markets. Journal of Applied Econometrics, 18 (1), 23-46.
PANDEY, I., 2003. Financial Management, 8th ed. New Delhi: Sultan Chand.
PENMAN, S., 2003. The Quality of Financial Statements: Perspectives from the
Recent Stock Market Bubble. Journal of American Accounting Association
[online], 17 (1). Available from: http://www.atypon-
link.com/AAA/doi/abs/10.2308/acch.2003.17.s-1.77?journalCode=acch
[Accessed 12 March 2007].
POTERBA, J. & SUMMERS, L., 1988. Mean-reversion in Stock Prices:
Evidence and Implications. Journal of Financial Economics, 22, 27-59.
PRIMARY RESEARCH METHODS [online]. Welsh Assembly Government.
Available from: http://www.elwa.ac.uk/elwaweb/elwa.aspx?pageid=2097
[Accessed 15 May 2007].
RAIFFA, H., 1968. Decision Analysis. Reading, MA: Addison-Wesley, 174.

105
RANADE, S., 2007. A Bull in Bear’s Clothing? [online]. The Hindu Businessline.
8th March 2007. Available from:
http://www.blonnet.com/2007/03/08/stories/2007030801021600.htm [Accessed
14 March 2007].
RAPPOPORT, P. & WHITE, E., 1993. Was the Crash of 1929 Expected?
American Economic Review, 84 (1), 271-281.
RESERVE BANK OF INDIA, 2007. Price Situation [online]. Mumbai. Available
from: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=9228 [Accessed 23
May 2007].
RESERVE BANK OF INDIA, 2007. The Indian Economy: Review and Prospects
[online]. Available from: http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/77370.pdf
[Accessed: 29 May 2007].
ROBERTS, H., 1959. Stock Market Patterns and Financial Analysis:
Methodological Suggestions. Journal of Finance, 44, 1-10.
ROSEN, B., SANDLER, D. & SHANI, D., 1991. Social Issues and Socially
Responsible Investment Behaviour: Preliminary Investigation. Journal of
Consumer Affairs, 25 (2), 221-234.
SAHURAJA, 2003. The Stock Exchanges Paranoid and the Indian Economy.
Mumbai: Lalwani, 314-356.
SAMUELSON, P., 1965. Proof That Properly Anticipated Prices Fluctuate
Randomly. Industrial Management Review, 6, 41-49.
SCHOLES, M., 1972. The Market for Securities: Substitution Versus Price
Pressure and the Effects of Information on Share Prices. Journal of Business, 45,
179-211.

106
SHILLER, R., 1987. Investor Behaviour in the October 1987 Stock Market Crash.
National Bureau of Economic Research Working Paper, No. 2446.
SHILLER, R., 1990. Market Volatility and Investor Behaviour. American
Economic Review, 80 (2), 58-62.
SHILLER, R., KON, Y. & YOSHIRO, T., 1991. Investor Behaviour in the
October 1987 Stock Market Crash: The Case of Japan. Journal of the Japanese
and International Economies, 5 (1), 1-13.
SINGH, A., 2006. Financial Liberalisation, Stockmarkets and Economic Growth.
The Economic Journal, 5 (1), 1-13.
SOROS, G., 1987. The Alchemy of Finance, New York: Simon and Schuster.
SUMMERS, L., 1986. Does the Stock Market Rationally Reflect Fundamental
Values? Journal of Finance, 41, 591-601.
THE MAD MARRIAGE MARKET OF EUROPE’S STOCK EXCHANGES
[online]. Available from:
http://www.europesworld.org/EWSettings/Article/tabid/78/Default.aspx?Id=63d4
cc85-cb84-4c5c-a0ed-39a6d6dc8e3f [Accessed 15 May 2007].
TRAIN, J., 1989. The New Money Masters. New York: Harper Collins.
VARMA, A., 2006. Financial Statement Analysis: Prudent Investors’ Tool. New
Delhi: Vikas.
WHITE, E., 2006. Bubbles and Busts: The 1990s in the Minor of the 1920s.
National Bureau of Economic Research Working Paper, No. 12138, 204-276.
ZHENHUA, Y., 2004. Stock Market Crashes [online]. Available from:
http://guava.physics.uiuc.edu/~nigel/courses/569/Essays_2004/files/yu.pdf
[Accessed 11th March 2007].

107
 APPENDIX – I
QUESTIONNAIRE DISTRIBUTED AMONG RETAIL INVESTORS
1. Annual household income (Mark in the applicable box)

1. Less than Rs. 2,50,000 2. Rs. 2,50,000, to Rs. 4,00,000

3. Rs. 4,00,001 to Rs. 8,00,000 4. Rs. 8,00,001 to Rs. 10,00,000
5. Rs. 10,00,000 and above 6. Prefer not to disclose

2. Value of investments (Mark in the applicable box)

1. Less than Rs. 1,00,000 2. Rs. 1,00,001 to Rs. 5,00,000

2. Rs. 5,00,001 to Rs. 10,00,000 4. Rs. 10,00,001 to Rs.15,00,000
5. Rs. 15,00,000 and above

3. In the next six months I expect the stock market to… (Circle the applicable
number).
1. Rise 2.Stay the same 3. Fall

4. Over the next six months I expect to …..

1. Put more money into investments (excluding regular contributions to
retirement funds deducted at source or through Public Provident Fund
[PPF])
2. Maintian investments at their current level
3. Take money out of the investments

5. Do you study the stock market by yourself? Please specify the way you do it.
(Please specify the names of newspapers or websites)

6. Do you take broker’s advice? If yes, do you act on it or do you compare it with
your own study of the stock markets?

7. Do you adopt any other methods to decide on your investments?

108
8. How important do you feel is it to increase the knowledge of your investments
and stock markets? (Rank from 1 to 10; 1 being the most important)
_______________

9. How often do you buy and sell your investments in a year? (Please specify
period)

10. How many different companies do you invest at a time?

__________________

11. What sector do you invest mainly in? (Please give details of sectors with the
maximum money invested being the first and minimum the last)

12. How old are you? (Please circle the applicable box).

1. 21-25 2. 25-35 3. 35-40 4. 40-45 5. 45-55 6. 55-65 7. 65 and above

13. What is your occupation? (Please specify the nature of your work)

1. Student
________________________________________________________
2. Professional
____________________________________________________
3. Government servant (incl defence or ex-defence)
4. Private service
__________________________________________________
5. Retired
6. Housewife
7. Others
_________________________________________________________

14. What are your educational qualifications?

1. 10+2 (Stream)
___________________________________________________

109
 2. Graduate (Stream)
_______________________________________________
3. Post Graduate (Specialisation)
______________________________________
4. Member of a professional body (ICAI, ICWAI, Medico, Lawyer, etc.)
____________________________________________________________
___
5. Others
_________________________________________________________

15. What is your gender?

Male Female

110