The Economic Journal of Nepal, Vol. 35, No. 3, July-September 2012 (Issue N0.

139) © CEDECON-TU

Analysis of Stock Market Efficiency

Basanta Kumar Mishra1

Abstract
This paper examines the weak form of market efficiency of the Nepalese
stock market employing autocorrelation test, runs test, variance ratio test,
and unit root test on monthly closing prices and market index for the period
mid-2003 to mid-2012. The study result reveals that the monthly return
series of Nepalese companies listed in Nepal stock exchange, and market
return series do not follow any predictable pattern. It suggests that any
speculation based on information on past stock price is fruitless. It implies
that all information conveyed in stock price in the past are impounded into
the current price of the stock. Thus, the opportunity of making abnormal
returns based on information on past stock price in the Nepalese stock
market is ruled out.

Introduction
The concept of capital market efficiency can be understood from various perspectives
namely: allocation efficiency2, operational efficiency3 and informational efficiency4. In financial
literature, market efficiency exclusively refers to informational efficiency. An efficient market
simply does not waste information. Market efficiency in this context refers to market’s ability to
price securities correctly and change securities price to reflect new information on securities
price correctly and instantaneously. Thus, an efficient market is one where current price of any
capital asset gives best estimate of its true value (the present value of the future prospects). If the
market is efficient, the current price is an unbiased estimate of its true economic value based on
the historical, public and private information. Fama formalized this concept as Efficient Market
Hypothesis (EMH) in the early 1960s. Depending on the information set to which prices adjust,
Fama (1970) divided EMH into following sub-hypothesis: a) Weak form efficient market (Prices
adjust/reflect all historical information of past stock prices or returns) b) Semi-strong form
efficient market (Prices adjust/reflect all publicly available information correctly and
instantaneously) and c) Strong form efficient market (Prices adjust/reflect all available
information including ‘insider’ information).

1
Mishra is a teacher of Nepal Rastriya College, Kathmandu. Email: basantam99@gmail.com
2
There are enough securities to efficiently allocate risk.
3
Transactions costs are low, thereby enhancing trading of securities.
4
Market prices fairly and quickly reflect all available information.
 Mishra: Analysis of Stock Market Efficiency 187

The primary role of the capital market is allocation of ownership of the capital stock of an
economy. If the stock market is efficient the limited saving is allocated to the productive
investment sector optimally resulting stream of benefits to the individual investors and to the
economy of the country as a whole.
The efficiency or inefficiency of the stock market largely depends upon availability and
accessibility of information. Information must widely available and accessible at minimum cost
and at, more or less, the same time around the market. Similarly, transaction costs, development
of regulatory institutions, awareness of investors, effective enforcement of rules and regulations,
market discipline, corporate governance etc. determine the efficiency level of stock market. A
market should to be large and liquid. Investors must also have enough funds to take advantage of
inefficiency until, according to the EMH, it disappears again. In order for a market to become
efficient, investors must perceive that a market is inefficient and possible to beat. Investment
strategies intended to take advantage of inefficiencies are actually the fuel that keeps a market
efficient.
In an efficient market, by definition, today’s price change reflects today’s news and
tomorrow’s price change will reflect tomorrow’s news. News is, by definition, unpredictable,
and, thus, resulting price changes must be unpredictable and random. If the flow of information
is unimpeded and information is immediately reflected in stock prices, in finance, such stochastic
properties of stock return series is termed by specific analogy ‘Random Walk Model (RWM)’ or
‘random walk theory’. The simplest RWM expressing such behavior of stock price can be
expressed as follow:
Pt = pt -1 + rt …...….……….…...…......... (1)
Where, Pt is the price of the stock at time t; Pt-1 is the price of the stock in the immediately
preceding period; rt is a reflection of news (return/loss) at time t.
In an efficient stock market, stock return series should move randomly with respect to new
information. Return series whose successive values are serially independent or follow random
walk, accepts the weak form EMH among three forms of EMH and the investors cannot derive
profitable investment strategy based on historical information. To the contrary, return series
whose successive returns are serially correlated, investors expect to earn an abnormal return
(above the market return) on a risk adjusted basis through either technical analysis or
fundamental analysis or both. The sense is that it is possible to ‘beat the market’. Such
dependence rejects the weak form efficient market hypothesis.

In the underdeveloped capital market, the market participants are considered not to be well
informed and irrational compared to well organize markets. Price cannot be assumed to fully
reflect all available information. It cannot be assumed that investors will correctly interpret the
information that is released. Beside this, the corporation has greater potential to influence its own
stock’s market price and there is a greater possibility that its price will move about in a manner
not justified by the information available (Samuels & Yacout, 1981).

Nepalese stock market is considered as a nascent market. At present, there is tremendous

decline in the market capitalization of the real sector while looking to the Nepal Stock Exchange
(NEPSE). Without dominating role of real sector, the capital market cannot cope with the
188 The Economic Journal of Nepal (Issue No. 139)

problem of economic growth in the long run. Adequate efforts are required to generate market
efficiency through the fair competition among market practitioners, confidence of market
participants, adequate and true liquidity, transparent regulation, timely release of market
information etc. This study is an attempt to test whether the Nepalese stock market is weak form
efficient or not.

Literature Review

Bachelier (1900) had anticipated the concept of market efficiency in ‘theory of speculation’.
It is the earliest known study on behavior of price change. Bachelier had analyzed the
commodity prices and asserted that successive price changes between two periods are
independent with zero mean and its variance is proportional to the interval between the two time
periods. Bachelier had stated, “Past, present and even discounted future events are reflected in
market price, but often show no apparent relation to price changes”. He deduced that ‘the
mathematical expectation of the speculator is zero’ before Samuelson (1965) explained efficient
in terms of martingale. But Bachelier’s contribution was overlooked until his name appeared in
economics as an acknowledged forerunner, in a thesis on options-like pricing by Samuelson in
1956 (Mandelbrot & Hudson, 2004; Dimson et al., 2000) and subsequently published in English
by Cootner (1964).

Fama (1965) examined the distribution and serial dependence of stock market returns using
serial correlation and runs test and concluded that they follow a random walk. He stated his
conclusion as “it seems safe to say that this paper has presented strong and voluminous evidence
in favor of the Random Walk Hypothesis (RWH).” Harry Roberts (1967) coined the term
‘Efficient Markets Hypothesis’ and made the distinction between weak and strong form tests
(Sewell, 2011). Fama et al. (1969) undertook the first ever event study though Ball & Brown
(1968) were the first to publish an ‘event study’ and their conclusion was that the stock market is
efficient. Fama (1970) published first of his three review papers on ‘efficient capital markets: A
review of theory and empirical work’. He defined an efficient market as: “A market in which
prices always ‘fully reflect’ available information is called ‘efficient’”. Realizing this notion as a
paradigm of efficient capital market, numerous studies have been performed to investigate the
level of efficiency of different developed and developing capital markets in the world.

Watts (1978) found statistically significant abnormal returns. He provided the first explicit
test to determine whether those abnormal returns emanate from market inefficiency or from
deficiencies in the asset-pricing model. His conclusion was that the abnormal returns are due to
market inefficiencies. Fama & French (1988) analyzed the US stock portfolio data. Their
conclusion was that the 25 to 40 percent of the variation in long holding period returns can be
predicted because of the mean reversion. Lo and MacKinlay (1988) used equal and value
weighted return regarding to NYSE listed stock for the period 1962 to 1985. They found positive
autocorrelation; inconsistent result with Fama and French (1988) for weekly holding-period
returns both for the entire sample and for all sub-periods using variance ratio test. Poterba and
Summers (1988) and De Bondt and Thaler (1989) found mean reversion in stock market returns
at longer horizons. However, Poterba and Summers (1988) found that the short periods’ stock
returns show positive autocorrelation. Fama (1991) empirically studied and detected a number of
anomalies such as the January effect, effect of holiday, effect of weekend and small size effect.
 Mishra: Analysis of Stock Market Efficiency 189

Campbell and Shiller (1988) reported that initial P/E ratios explain as much as 40 percent of the
variance of future returns. They conclude that equity returns were predictable in the past to a
considerable extent.

There are number of studies on different individual markets as well as on regional markets of
Asian countries. Pan et al. (1991) analyzed daily and weekly market returns of five Asian stock
markets (Hong Kong, Japan, Singapore, South Korea, and Taiwan) using variance ratio test.
Their results indicate that all the market returns based on the five market indices were positively
autocorrelated except for Japan. Similar results were found by Dickinson and Muragu (1994) for
Nairobi stock market; Cheung et al. (1993) for Korea and Taiwan; Poshakwale (1996) for Indian
stock market; Lee et al. (2001) for China; Hassan et al. (2007) for Karachi Stock Exchange.
Huang (1995) examined the RWH for the nine Asian equity markets using the variance ratio
statistics. He rejected the RWM hypothesis for the equity markets of Hong Kong, Singapore,
Thailand, Korea and Malaysia. Hamid et al. (2010) tested the weak form market efficiency of the
monthly stock market returns of Pakistan, India, Sri Lanka, China, Korea, Hong Kong,
Indonesia, Malaysia, Philippine, Singapore, Thailand, Taiwan, Japan and Australia for the period
January 2004 to December 2009. Autocorrelation, Ljung-Box Q-statistic test, runs test, unit root
test and the variance ratio were used. They concluded that monthly returns are not normally
distributed. They suggested that the investors can take the stream of benefits through arbitrage
process from profitable opportunities across these markets.

Groenewold and Kang (1993) found Australian market semi-strong form efficient.
Conclusion of Magnusson and Wydick (2000) is in favor of RWH for African stock market.
Cheung and Coutts (2001) used a variance ratio test and found that the Hong Kong stock market
return follow a random walk. Similar results for Korean stock market were found by Ryoo and
Smith (2002) using variance ratio test. Worthington and Higgs (2004) investigated indices of 20
European stock markets for the period August 1995 to May 2003 by applying serial correlation
test, runs test, variance ratio test and Augmented Dickey Fuller (ADF) test. They concluded that
all indices are not normally distributed and only the indices of Germany, Ireland, Portugal,
Sweden and the United Kingdom follow random walk purely and France, Finland, Netherlands,
Norway and Spain are following the RWH. Similarly, Worthington and Higgs (2009) examined
efficiency in the Australian stock market for the period of 12,519 daily and 1,575 monthly
observations and reported that the monthly Australian stock returns follow a random-walk, but
daily returns do not because of short-terms autocorrelation in returns.

Borges (2008) conducted study on the equity markets of France, Germany, UK, Greece,
Portugal and Spain, for the period January 1993 to December 2007 using serial correlation test,
ADF test, runs test and multiple variance ratio. They found that monthly prices and returns
follow RWM in all six equity markets. However, they detected the serial positive correlation for
Greece and Portugal before year 2003. Urrutia (1995) investigated the RWM for four Latin
American emerging stock markets: Argentina, Brazil, Chile and Mexico. The variance ratio test
of the monthly return data detected the RWH but runs test indicated that there exists weak form
of efficiency regarding to these markets. He pointed out the two reasons behind this scenario.
The first is the domestic investors are not enough competent to design trading strategies that may
allow them to earn excess returns and the second is both the economy and the capital markets of
developing countries have been growing at an unusually rapid pace, and it is likely that positive
190 The Economic Journal of Nepal (Issue No. 139)

autocorrelations are indicators of economic growth rather than evidence against the efficient
market hypothesis. Linking between the market inefficiency and economy, he concluded that the
four Latin American emerging equity markets are weak form efficient.

Pradhan and Upadhyay (2004) made a conclusion that the Nepalese stock market may not be
termed as ‘weekly efficient’ in pricing of shares. They conducted a opinions survey and
concluded that the current market price of shares are useful to make buy or sell decision, to
predict average returns, and to predict future prices. K.C. and Joshi (2005) examined the various
forms of anomalies empirically in the Nepalese stock market for daily data of Nepal stock
exchange return from February 1, 1995 to December 31, 2004. Using regression model with
dummies, they found persistent evidence of day-of-the week anomaly but disappearing holiday
effect, turn-of-the-month effect and time of-the-month effect. They also documented no evidence
of month-of-the-year anomaly and half-month effect. The results indicate that the Nepalese stock
market is not efficient in weak form with regard to the day-of-the week anomaly but weakly
efficient with respect to the other anomalies.

Dangol (2008) examined the impact of new unanticipated political events in the Nepalese
stock market using the event analysis methodology. He concluded that good-news/bad news
generate positive/negative abnormal returns in the post-event period. Bhatta (2010) tested the
RWH on daily, weekly and monthly market returns and returns of 30 individual listed companies
in NEPSE for the period of 1996 to 2005 using autocorrelation test and runs test. The results
show that stock prices in Nepal are not moving independently confirming the Nepalese stock
market is not weak form efficient.

Methodology of the Study

Statistical and Econometrical Tools

Autocorrelation Test

The autocorrelation is correlation between members of same series. Thus, it is used to detect
the relationship between the value of a time series in time t and its value of the k period earlier in
the same time series. A significant positive autocorrelation implies that the value of a time series
in time t depends on its value of the k period earlier in the same time series and vice-versa. Thus,
a time series needs a zero autocorrelation coefficient at different lags to be random. The sample
autocorrelation coefficient k is defined as:

Cov(rt , rt k )
k = ..............................................3.1.1
Var (rt )

A time series is purely random, that is, it exhibits white noise, when the autocorrelation
coefficients are normally distributed with zero mean and variance equal to one over the sample
in the large samples. Symbolically, k ≈ N(0, 1/n) (Bartlett, 1946). Instead of testing the
statistical significance of any individual autocorrelation coefficient, this study has tested the joint
 Mishra: Analysis of Stock Market Efficiency 191

hypothesis that all the k up to certain lags is simultaneously equal to zero using the Ljung Box
(LB) statistic (Ljung & Box, 1978) which is defined as:

m   2 
LB = n(n+2)      2 .............................3.1.2
k

 
k 1  n  k 

Where, n = sample size and k = lag length.

The LB-statistics follow the chi-square (χ2) distribution with m degrees of freedom. The null
hypothesis of independence is rejected if LB-statistic is greater than χ2 with m degrees of
freedom at the corresponding significance level (α).

Runs Test

A run is defined as an uninterrupted sequence of one symbol or attribute, such as + or -. The

number of elements in a run is defined as a length of run (Gujarati et al., 2012). If return/loss
series (Rt) = -3, +2, +1, -2, +1 then Rt contains four runs. The probability that the tth value is
larger or smaller than the µ value (i.e. mean or median or any custom value) follows a binomial
distribution, which forms the basis of the runs test. The premise behind the runs test is that too
few or too many runs, as compared with the number of runs, expected in a random series,
indicates non-randomness. If there are too many runs in Rt, it would mean that the stock returns
change sign frequently, thus, indicating a negative autocorrelation and vice-versa. If the observed
runs are not significantly different from the expected number of runs then it is concluded that
successive prices changes are independent.

The runs test is a non-parametric test of randomness in a series. This approach test and
detects statistical dependency which may not be detected by the autocorrelation analysis. It is
possible that securities prices might change randomly most of the time but occasionally follow
trends that autocorrelation cannot detect and runs test are used to determine if there are such runs
in price changes. Under the null hypothesis, the successive outcomes (here monthly returns) are
independent and identically distributed; the number of runs is asymptotically normally
distributed with

2 N1 N 2 2 N1 N 2 (2 N1 N 2  N )
 1 and variance:  R 
2
mean: E(R) =
N ( N ) 2 ( N  1)

Where, N = total number of observations = N1 + N2, N1 = number of positive returns, N2 =

number of negative returns and R = number of runs.

These parameters do not assume that the positive and negative elements have equal
probabilities of occurring, but only assume that the elements are independent and identically
distributed. For a large sample the test statistic is defined as:
192 The Economic Journal of Nepal (Issue No. 139)

R  E ( R)
Z= ......................................3.2.1
R2

The Z-value greater than or equal to ± 1.96 rejects the null hypothesis at 5 percent level of
significance. Alternatively, if the value of asymptotic significance is found greater than 0.05 the
RWH should be accepted at 5% level of significance.

Variance Ratio Tests

Variance ratio tests are widely used and particularly useful for examining the behavior of
stock price indices in which returns are frequently not normally distributed. These tests are based
on the variance of returns and have good size and power properties against interesting alternative
hypotheses and in these respects are superior to many other tests (Campbell et at., 1997). The VR
methodology consists of testing the RWH against stationary alternatives, by exploiting the fact
that the variance of random walk increments is linear in all sampling intervals, i.e. the sample
variance of the k-period return (or k-period differences), Pt-Pt−k, of the time series Pt, is k times
the sample variance of the one-period return (or the first difference), Pt - Pt−1. This can be
expressed symbolically as follow:

Var(Pt -Pt - k) = kVar(Pt - Pt - 1) or

Var(rk) = kVar(r1) ………………………………….(3.3.1)

In which, k is any positive integer. The variance ratio is given by:

1  2
1 Var(r k ) (r )
VRk = k
= k 2 k ……………….…………(3.3.2)
Var(r1 )  ( r1 )

Where, rk is k-period’s continuously compounded return.

The variance ratios computed at each individual lag interval k (k = 2, 3, . . .) should be equal
to unity for a random walk process. Variance-ratio values below one and decrease with increase
in k indicates negative serial correlation in the returns i.e. mean reversion. Variance-ratio values
above one and increase with increase in k indicates positive serial correlation in the returns i.e.
mean aversion.

Lo and MacKinlay (1988) generate the asymptotic distribution of the estimated variance
ratios and recommended two test statistics, Z(k) and Z*(k), both of which have asymptotic standard
normal distributions under the null hypothesis. Z(k) is derived under the assumption that the
disturbances of time series are homoscedastic but under the heteroscedastic assumption Z*(k) is
derived. Z*(k) statistic is not only sensitive to correlated changes in stock prices, but also robust to
many general forms of heteroscedasticity and nonnormality and so is particularly useful with
stock returns because often they are not normally distributed (Smith et al., 2003). The test
statistic Z(k) is given by:
 Mishra: Analysis of Stock Market Efficiency 193

VR(rt ; k)−1
Z(k) = ……………………………..……..….(3.3.3)
∅(k)1/2

Where, the asymptotic variance,∅(k), is given by:

2(2k−1)(k−1)
∅(k) = …………………..….……….…….. (3.3.4)
3kN

The test statistic Z*(k) is given by given by:

VR(rt ; k)−1
Z*(k) = ………………...……………….…..……. (3.3.5)
∅∗ (k)1/2

Where,

 N   N 
2
 2(k  j ) 
2
2
k 1   
∅ (k) =  
∗
 ( j ) and,  ( j )   t ( x   ) 2
( x   ) 2
  t
  ( x   )  
k 
t j
j 1  t  j 1   t 1  

Both statistics follow the standard normal distribution asymptotically under the null
hypothesis that VR(k) = 1.

It is usual to examine the VR statistics for several k values (ki, i = 1, 2, 3, ……., m). The null
random walk is rejected if it is rejected for some k value. Chow & Denning, (1993) have
suggested a procedure for the multiple comparison of the set of variance ratio estimates with
unity as an alternative of such sequential procedure. This test consider the joint null hypothesis
H0: VR (ki) = 1 for all i = 1, . . . , m, against the alternative H1: VR(ki) ≠1 for some ki. The test
statistic is given by,

a. Under homoscedastic assumption: Max {| Z(k1) |,….., |Z(km)|} and,

b. Under heteroscedastic assumption: Max {| Z*(k1) |,….., | Z*(km)|}.

The null hypothesis is tested on the basis of following results:

a. Under homoscedastic assumption: Prob.{max (| Z(k)| ≤ SMM (α, m , N)} ≥ 1- α and

b. Under heteroscedastic assumption: Prob. {max (|Z*(k)| ≤ SMM (α, m , N)} ≥ 1- α.

Where, SMM (α; m; N) is the upper α point of the Studentized Maximum Modulus (SMM)
distribution with m parameters and N (sample size) degrees of freedom. When N is infinite,
asymptotically,

Z
SMM (α, m, N) = 
2 …………………………….(3.3.8)

Z
In which, 
2 = standard normal distribution and α+ = 1-(1-α)1/m.
194 The Economic Journal of Nepal (Issue No. 139)

If the maximum absolute value of chosen statistic, Z(k) or Z*(k), is greater than the SMM
critical value at a predetermined significance level then the RWH is rejected. Chow and Denning
(1993) control the size of the MVR test by comparing the calculated values of the standardized
test statistics, either Z(k) or Z*(k) with the SMM critical values.

Unit Root Test

Let us write the equation (1) as:

Pt = ρPt-1+ rt ………………… (3.4.1)

Where, ρ lies between -1 to 1 i.e. -1 ≤ ρ ≥ 1.

If ρ is 1 i.e. unit root, then (3.4.1) becomes a RWM. Such stochastic process is said to be unit
root or nonstationary. Nonstationarity is the necessary condition for RWM. Unit root test is a
popular test of nonstationarity (or stationarity). We cannot estimate equation (3.4.1) by OLS and
test the hypothesis that ρ = 1 by the usual t test because that test is severally biased in the case of
unit root (Gujarati et al., 2012) Therefore, manipulating equation (3.4.1) can be written as:

ΔPt =  rt-1 + rt ……………………………………..(3.4.2)

Where, ΔPt =Pt - Pt-1 and  = (ρ -1).

Hence, null hypothesis is  = 0. Acceptance of the null hypothesis indicates the time series
is nonstationary or unit root. The errors (residuals) in the equation (3.4.2) may be serially
correlated. Therefore, to obtain unbiased estimate of  ADF test (Dickey & Fuller, 1979 &
1981) has been used. In the case of random walk without drift and trend the ADF test consists of
estimating the following regression:

m
ΔPt = Pt 1    i Pt -i  rt ..................................................(3.4.3)
i 1

Schwarz information criterion has been used to determine the optimal lag length (m).

Nature and Sources of Data

Monthly closing NEPSE index, monthly closing price per share and dividend per share has
been used in this study. Monthly return series during mid 2003 to mid 2012 have been used in
this study. These data are collected from NEPSE, Securities Board of Nepal and individual
sample companies listed in NEPSE.

Market return on period t (rmt) is calculated as:

Rmt = ln(PIt) - ln(PIt-1) …………………………………(7)

Where, ln = natural logarithms, PIt = Price Index at time t and PIt-1 = Price Index at time t-1
 Mishra: Analysis of Stock Market Efficiency 195

Similarly, return of an individual company on period t (rt) is calculated as:

ln(Pt +Dt) - ln(Pt-1) ………………………………….. (8)

Where, Pt = Price per share at time t, Pt-1 = Price per share at time t-1 and Dt = Dividend per
share of an individual company at time t.

Logarithms price difference is continuously compounded and free from magnitude bias.
Without logarithm price difference, a fifty rupees increase on a share initially priced at hundred
is similar to a fifty rupees increase on a share initially priced at thousand, is an example of
magnitude bias.

Selection of Companies

Some periods may show a zero return as a result of the thin trading. Estimated returns may
differ from true returns. Therefore, highly frequently traded companies are selected from
respective sub-groups to save the data from thin trading bias. At least one company has been
selected to represent all the sub-groups, as categorized by NEPSE as shown in table 1.

Table 1: Selection of Companies

Sub-groups CB DB FC IC Hotel MP Trading Hydro Other Total
Total listed companies 26 68 69 21 4 18 4 4 2 216
No. of selected companies 9 5 4 4 1 1 1 2 1 28
Source: NEPSE, Mid 2012

Where, CB = Commercial Banks, DB = Development Banks, FC = Finance Companies, IC =

Insurance Companies and MP = Manufacturing and Processing companies. In addition the return
series of these 28 individual companies, NEPSE return series also has been analyzed in this
study.

Presentation and Analysis

Outcomes of autocorrelation test (Ljung-Box (LB) statistics), runs test, variance ratio test
(multiple comparison of the set of variance ratio suggested by Chow & Denning (1993)) and unit
root test (ADF test statistics) have been presented in table 2.

Autocorrelation coefficients were calculated up to 30 lags. LB values and respective

probabilities in the Table 2 represent LB statistics of lag 30. Same values for 1, 5, 10, 15, 20, 25
and 30 lags are presented in appendix-I. Z values and respective probabilities of runs test are
presented in this table. Details of runs test are presented in appendix-II. |Z(k)| and |Z*(k)| values
were calculated for k = 2, 3, …, 16, i.e. parameter value (m) = 15. Among those largest |Z(k)| and
|Z*(k)| values and respective k values and probabilities are presented in this table. Details of
variance ratio test of NEPSE (only) are presented in appendix-III. ADF (t) values and respective
probabilities of unit root test at level are presented in this table. Details of ADF test at level and
at first difference are presented in appendix-IV.
 196 The Economic Journal of Nepal (Issue No. 139)

Table 2: Statistical Tests

Multiple Variance Ratio Test
Autocorrelation Runs Test Joint Test Under Joint Test Under
Unit Root Test
Test homoscedastic assumption heteroscedastic assumption
{Z(k)} {Z*(k)}
LB Z |Z(k)| Max |Z(k)| Prob. |Z*(k)| Max |Z*(k)| Prob. ADF
Companies Prob. Prob. Prob.
Values Values Max at k Values Max at k Values Values
ACEDBL 28.097 .565 2.051** 0.040 k=7 1.094 0.992 k=7 1.052 0.995 -1.473 0.131
BBC 23.978 .773 -0.281 0.779 k = 15 0.553 1.000 k=3 0.705 1.000 -0.556 0.473
BOK 47.025** .025 -1.954 0.051 k = 16 2.207 0.340 k = 16 2.342 0.252 0.595 0.844
BUDBL 22.748 .825 0.906 0.365 k=6 0.734 1.000 k=6 0.903 0.999 -0.917 0.315
CEDBL 20.528 .902 0.177 0.860 k=5 1.112 0.990 k=4 1.659 0.784 -0.988 0.285
CHCL 31.967 .369 0.173 0.862 k = 14 0.747 1.000 k = 14 0.812 1.000 1.056 0.923
EBL 25.126 .719 -0.906 0.365 k=2 2.485 0.178 k=2 1.000 0.997 1.014 0.918
HBL 70.281* .000 0.480 0.631 k = 10 1.206 0.979 k = 10 1.208 0.979 -0.181 0.619
ICFC 15.201 .989 1.782 0.075 k=2 3.241** 0.018 k=2 2.723 0.093 -0.903 0.322
ILFC 42.695 .062 1.005 0.315 k = 15 1.634 0.802 k=6 1.512 0.877 -0.071 0.656
KBL 30.900 .420 -1.262 0.207 k=2 1.461 0.903 k=2 1.362 0.942 0.051 0.697
LICN 26.719 .638 -1.544 0.123 k = 16 1.598 0.826 k = 16 1.562 0.849 1.873 0.985
NABIL 49.909** .013 0.196 0.845 k = 16 2.067 0.447 k = 16 2.105 0.416 0.616 0.848
NBB 27.761 .583 0.190 0.849 k=2 2.390 0.225 k=2 1.701 0.753 -0.300 0.576
NDEP 46.756** .026 2.301** 0.021 k=2 2.493 0.174 k=2 2.112 0.412 -3.507* 0.001
NEPSE 41.218 .083 -2.529** 0.011 k = 16 2.954** 0.046 k = 16 2.893 0.056 1.021 0.919
NHPC 13.407 .996 -2.200** 0.028 k=4 0.957 0.998 k=5 0.767 1.000 -0.901 0.323
NIB 38.977 .126 -1.283 0.199 k=4 1.396 0.930 k=4 1.572 0.843 -0.062 0.660
NLIC 47.182** .024 -1.846 0.065 k = 16 1.664 0.780 k = 16 1.639 0.798 1.747 0.980
NTC 11.212 .999 -0.076 0.939 k=2 2.559 0.147 k=2 5.309* 0.000 -1.264 0.188
OHL 32.251 .356 -0.785 0.432 k = 16 2.652 0.114 k = 16 2.494 0.174 0.770 0.878
PLIC 21.040 .887 -0.151 0.880 k=3 1.457 0.905 k=3 1.092 0.992 0.301 0.767
PRFL 45.482** .035 0.881 0.379 k=3 3.018** 0.037 k=3 3.625* 0.004 -3.234* 0.002
RIBSL 41.442 .080 1.362 0.173 k=4 1.821 0.656 k=4 2.139 0.390 -1.664 0.090
SBI 34.400 .265 0.468 0.640 k=3 1.193 0.981 k=3 1.235 0.974 0.646 0.855
SCB 59.598* .001 -2.546** 0.011 k = 16 1.414 0.923 k = 16 1.414 0.923 0.062 0.701
SIL 14.327 .993 0.383 0.702 k=2 1.689 0.762 k=2 1.337 0.950 -0.203 0.609
SUPRME 24.503 .749 -0.217 0.828 k=3 2.082 0.435 k=3 1.571 0.843 -0.361 0.550
UNL 26.717 .638 -0.861 0.389 k=2 0.930 0.999 k=2 1.098 0.992 3.583 1.000
* Significant at 1% level, ** Significant at 5% level

Autocorrelation Test
Autocorrelation test (LB statistic) results support the weak form efficiency for 21 (75%)
individual companies and reject for rest 7 (25%) individual companies at 5 percent level of
significance. Autocorrelation test (LB statistic) results have supported the weak form efficiency
for NEPSE return series at 5 percent level of significance.
Runs Test
Runs test results support the weak form efficiency for 24 (85.71%) individual companies and
reject for rest 4 (14.29%) individual companies at 5 percent level of significance. Runs test
results have rejected the weak form efficiency for NEPSE return series at 5 percent level of
significance. The result of runs test of NEPSE are similar to the findings of Poshakwale (1996)
who found that the actual number of runs significantly lower than expected number of runs for
daily returns in India, Philipins, malaysia, and Thailand.
Variance Ratio Test (Z(k) Statistics)
The hypothesis that the logarithm of the stock price follows a homoscedastic random walk is
accepted for return series of 26 (92.86%) individual companies and rejected for rest 3 (10.71%)
individual companies at 5% level of significance. Like the runs test, variance ratio test statistic
(Z(k)) has rejected the weak form efficiency for NEPSE return series at 5% level of significance.
In principle, the rejection of the hypothesis that the logarithm of the stock price follows a
 Mishra: Analysis of Stock Market Efficiency 197

homoscedastic random walk could result from either heteroscedasticity or autocorrelation in the
stock price index.
Variance Ratio Test (Z*(k) Statistics)
Variance ratio test statistics (Z*(k)) results accept the weak form efficiency for 26 (92.86%)
individual companies and reject for rest 2 (7.14%) individual companies. Unlike the test statistic
(Z(k)), (Z*(k)) has accepted the weak form efficiency for NEPSE return series at 5 percent level of
significance. Hence, rejection of the hypothesis that the logarithm of the NEPSE return follows a
homoscedastic random walk results from heteroscedasticity rather than autocorrelation in the
NEPSE return.
Unit Root Test
ADF test results support the null hypothesis of unit root in return series for 26 (92.86%)
individual companies and reject for rest 2 (7.14%) individual companies. ADF test result has
accepted the null hypothesis of unit root in NEPSE return series at 5 percent level of
significance. By applying unit root test the results reveal that the data series become stationary at
order I (1).

Conclusions

Findings of different tests, though some inconsistency between them, indicate that Nepalese
stock market is efficient in weak form. The study result reveals that the monthly return series of
Nepalese companies listed in Nepal stock exchange and market return series do not follow any
predictable pattern. It implies that all information conveyed in stock price in the past are
impounded into the current price of the stock. Thus, the opportunity of making excess returns
based on information on past stock price in the Nepalese stock market is ruled out. This finding
is inconsistent with previous studies by Pradhan and Upadhyay (2004), Bhatta (2010) etc. It is
also doubtful about consistency of the result, when the observations are split up into sub-
samples. Little bit predictability on stock price is cancelled by costly transaction process. Hence,
analysis of past stock price of the companies listed in NEPSE is fruitless.

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200 The Economic Journal of Nepal (Issue No. 139)

Appendix I: Autocorrelation test

Companies Lags 1 5 10 15 20 25 30
Autocorrelation Coefficients -0.068 -0.002 0.043 0.042 -0.247 -0.043 .007
ACEDBL Values 0.342 6.063 10.442 13.247 26.161 27.092 28.097
LB Statistics
Prob. 0.559 0.3 0.403 0.583 0.161 0.351 .565
Autocorrelation Coefficients 0.003 -0.131 0.131 -0.082 0.057 -0.092 .010
BBC Values 0.001 6.253 8.26 13.482 15.587 21.171 23.978
LB Statistics
Prob. 0.981 0.282 0.603 0.565 0.742 0.683 .773
Autocorrelation Coefficients 0.076 -0.163 0.123 0.035 0.094 -0.108 .008
BOK Values 0.716 7.7 19.694 25.333 28.965 39.401 47.025
LB Statistics
Prob. 0.398 0.174 0.032 0.046 0.088 0.034 .025
Autocorrelation Coefficients -0.06 -0.005 -0.026 0.13 -0.168 -0.002 .140
BUDBL Values 0.227 0.836 2.103 8.626 16.792 19.24 22.748
LB Statistics
Prob. 0.634 0.975 0.995 0.896 0.666 0.785 .825
Autocorrelation Coefficients -0.126 0.136 0.049 -0.156 -0.25 -0.054 -.039
CEDBL Values 0.877 5.034 6.444 11.711 17.984 18.539 20.528
LB Statistics
Prob. 0.349 0.412 0.777 0.701 0.588 0.819 .902
Autocorrelation Coefficients -0.027 -0.182 0.08 0.091 0.024 -0.105 .058
CHCL Values 0.065 5.086 13.719 22.885 26.303 28.648 31.967
LB Statistics
Prob. 0.798 0.405 0.186 0.087 0.156 0.279 .369
Autocorrelation Coefficients -0.233 -0.012 0.028 0.068 -0.054 0.029 -.010
EBL Values 6.702 7.886 10.011 19.35 21.436 23.347 25.126
LB Statistics
Prob. 0.01 0.163 0.44 0.198 0.372 0.557 .719
Autocorrelation Coefficients -0.096 -0.003 0.31 0.132 -0.01 -0.035 -.118
HBL Values 1.114 7.635 25.321 41.257 56.953 61.625 70.281
LB Statistics
Prob. 0.291 0.178 0.005 .000 .000 .000 .000
Autocorrelation Coefficients -0.242 -0.098 -0.061 -0.041 -0.062 -0.048 .026
ICFC Values 4.096 6.025 9.304 10.391 11.368 12.236 15.201
LB Statistics
Prob. 0.043 0.304 0.503 0.794 0.936 0.985 .989
Autocorrelation Coefficients -0.074 0.19 0.067 -0.028 0.054 -0.014 .000
ILFC Values 0.493 7.644 20.275 24.882 31.229 38.277 42.695
LB Statistics
Prob. 0.483 0.177 0.027 0.052 0.052 0.043 .062
Autocorrelation Coefficients -0.144 0.057 0.159 0.084 -0.071 -0.048 -.005
KBL Values 2.279 7.851 11.57 19.458 26.43 29.312 30.900
LB Statistics
Prob. 0.131 0.165 0.315 0.194 0.152 0.251 .420
Autocorrelation Coefficients 0.052 0.024 0.002 0.086 0.049 -0.022 -.067
LICN Values 0.319 1.331 5.469 10.034 13.756 17.785 26.719
LB Statistics
Prob. 0.572 0.932 0.858 0.818 0.843 0.851 .638
Autocorrelation Coefficients -0.005 0.074 0.031 -0.128 -0.018 0.039 .121
NABIL Values 0.003 1.642 8.353 32.726 35.237 44.814 49.909
LB Statistics
Prob. 0.959 0.896 0.594 0.005 0.019 0.009 .013
Autocorrelation Coefficients -0.182 -0.074 0.163 0.006 0.036 0.124 .059
NBB Values 3.956 5.843 12.389 15.452 19.598 25.708 27.761
LB Statistics
Prob. 0.047 0.322 0.26 0.419 0.483 0.423 .583
Autocorrelation Coefficients -0.354 0.285 0.013 -0.01 -0.172 -0.171 .078
NDEP Values 6.632 11.808 13.107 15.101 23.899 42.243 46.756
LB Statistics
Prob. 0.01 0.038 0.218 0.444 0.247 0.017 .026
Autocorrelation Coefficients 0.094 -0.071 0.237 -0.033 0.055 -0.109 .062
NEPSE Values 1.078 9.736 24.282 28.504 32.266 37.709 41.218
LB Statistics
Prob. 0.299 0.083 0.007 0.019 0.041 0.049 .083
Autocorrelation Coefficients -0.07 0.132 0.018 0.112 0.106 0.054 -.035
NHPC
LB Statistics Values 0.353 3.493 4.883 7.946 10.607 11.425 13.407
 Mishra: Analysis of Stock Market Efficiency 201

Prob. 0.552 0.625 0.899 0.926 0.956 0.991 .996

Autocorrelation Coefficients 0.033 -0.124 0.188 0.06 0.001 -0.046 .011
NIB Values 0.132 9.859 25.547 27.999 31.873 33.928 38.977
LB Statistics
Prob. 0.717 0.079 0.004 0.022 0.045 0.109 .126
Autocorrelation Coefficients 0.115 0.168 0.247 0.02 0.023 -0.067 -.019
NLIC Values 1.592 10.55 26.911 33.697 38.028 40.749 47.182
LB Statistics
Prob. 0.207 0.061 0.003 0.004 0.009 0.024 .024
Autocorrelation Coefficients -0.05 0.006 -0.01 0.034 -0.085 -0.095 -.014
NTC Values 0.154 4.228 6.617 7.174 8.818 11.006 11.212
LB Statistics
Prob. 0.695 0.517 0.761 0.953 0.985 0.993 .999
Autocorrelation Coefficients -0.002 0.284 0.145 -0.073 0.025 -0.062 -.146
OHL Values 0.001 11.779 19.518 22.94 24.81 26.415 32.251
LB Statistics
Prob. 0.982 0.038 0.034 0.085 0.209 0.386 .356
Autocorrelation Coefficients -0.153 -0.092 0.022 0.144 -0.11 0.016 -.004
PLIC Values 0.911 7.122 7.893 15.933 17.862 20.954 21.040
LB Statistics
Prob. 0.34 0.212 0.639 0.387 0.597 0.695 .887
Autocorrelation Coefficients -0.214 0.187 0.299 0.038 0.265 -0.137 -.073
PRFL Values 2.755 9.692 20.678 24.218 34.481 42.308 45.482
LB Statistics
Prob. 0.097 0.084 0.023 0.061 0.023 0.017 .035
Autocorrelation Coefficients -0.19 -0.094 -0.024 0.132 -0.148 -0.125 .002
RIBSL Values 1.911 10.04 13.281 15.023 22.975 33.127 41.442
LB Statistics
Prob. 0.167 0.074 0.208 0.45 0.29 0.128 .080
Autocorrelation Coefficients 0.057 -0.132 0.093 -0.005 0.062 -0.061 -.010
SBI Values 0.39 4.273 9.226 16.901 20.884 26.044 34.400
LB Statistics
Prob. 0.532 0.511 0.511 0.325 0.404 0.405 .265
Autocorrelation Coefficients 0.046 -0.084 0.083 -0.166 0.124 -0.062 -.206
SCB Values 0.263 3.994 10.633 37.689 42.505 52.196 59.598
LB Statistics
Prob. 0.608 0.55 0.387 0.001 0.002 0.001 .001
Autocorrelation Coefficients -0.192 -0.079 0.029 0.118 -0.018 0.04 -.062
SIL Values 2.426 4.341 5.643 8.41 10.131 10.621 14.327
LB Statistics
Prob. 0.119 0.501 0.844 0.906 0.966 0.995 .993
Autocorrelation Coefficients 0.235 0.088 0.006 0.007 -0.071 -0.031 .041
SUPRME Values 2.874 4.761 5.857 6.035 6.963 7.558 24.503
LB Statistics
Prob. 0.09 0.446 0.827 0.979 0.997 1 .749
Autocorrelation Coefficients 0.092 -0.015 0.099 -0.234 -0.039 -0.105 -.048
UNL Values 0.755 4.258 8.234 15.728 16.649 23.295 26.717
LB Statistics
Prob. 0.385 0.513 0.606 0.4 0.676 0.56 .638
202 The Economic Journal of Nepal (Issue No. 139)

Appendix II: Runs test

Test Value Cases < Cases ≥ Total Number of Asymp. Sig. (2-
Companies (Mean) Mean Mean Cases Runs Z tailed)
ACEDBL -0.024 37 34 71 45 2.051 0.04
BBC -0.004 31 38 69 34 -0.281 0.779
BOK 0.009 65 55 120 50 -1.954 0.051
BUDBL -0.019 31 30 61 35 0.906 0.365
CEDBL -0.021 22 30 52 27 0.177 0.86
CHCL 0.016 46 39 85 44 0.173 0.862
EBL 0.012 62 58 120 56 -0.906 0.365
HBL -0.001 57 62 119 63 0.48 0.631
ICFC -0.019 38 29 67 41 1.782 0.075
ILFC 0.004 46 41 87 49 1.005 0.315
KBL 0.002 54 53 107 48 -1.262 0.207
LICN 0.022 65 51 116 50 -1.544 0.123
NABIL 0.008 62 58 120 62 0.196 0.845
NBB -0.002 59 57 116 60 0.19 0.849
NDEP -0.043 26 24 50 34 2.301 0.021
NEPSE 0.008 64 56 120 47 -2.529 0.011
NHPC -0.016 39 30 69 26 -2.2 0.028
NIB 0.001 60 60 120 54 -1.283 0.199
NLIC 0.024 69 48 117 48 -1.846 0.065
NTC -0.015 27 32 59 30 -0.076 0.939
OHL 0.011 64 38 102 45 -0.785 0.432
PLIC 0.007 19 17 36 18 -0.151 0.88
PRFL -0.025 33 24 57 32 0.881 0.379
RIBSL -0.036 21 29 50 30 1.362 0.173
SBI 0.01 61 58 119 63 0.468 0.64
SCB 0.002 57 63 120 47 -2.546 0.011
SIL -0.001 32 31 63 34 0.383 0.702
SUPRME -0.009 27 22 49 24 -0.217 0.828
UNL 0.023 50 36 86 39 -0.861 0.389

Appendix III: Variance ratio test of NEPSE

Test Under homoscedastic assumption {Z(k)} Test Under heteroscedastic assumption {Z*(k)}
Joint Tests Value Prob. Joint Tests Value Prob.
Max |z(k)| (at k=16)* 2.954035 0.0460 Max |z*(k)| (at k=16)* 2.892914 0.0557
Individual Tests Individual Tests
Period (k) Variance Var. Ratio Z-Statistic Prob. Period (k) Variance Var. Ratio Z*-Statistic Prob.
1 0.00632 - - - 1 0.00632 - - -
2 0.00699 1.105849 1.159517 0.2462 2 0.00699 1.10585 1.138511 0.2549
3 0.00818 1.292988 2.153011 0.0313 3 0.00818 1.29299 2.142748 0.0321
4 0.00867 1.371524 2.175423 0.0296 4 0.00867 1.37152 2.140544 0.0323
5 0.00865 1.367155 1.835773 0.0664 5 0.00865 1.36715 1.779404 0.0752
6 0.00851 1.345633 1.531601 0.1256 6 0.00851 1.34563 1.474501 0.1403
7 0.00833 1.317594 1.276468 0.2018 7 0.00833 1.31759 1.227689 0.2196
8 0.00835 1.320906 1.188405 0.2347 8 0.00835 1.32091 1.144828 0.2523
9 0.00865 1.367156 1.267181 0.2051 9 0.00865 1.36716 1.223209 0.2213
10 0.00913 1.443140 1.437735 0.1505 10 0.00913 1.44314 1.390467 0.1644
11 0.00987 1.560066 1.719738 0.0855 11 0.00987 1.56007 1.666345 0.0956
12 0.01065 1.684544 2.000174 0.0455 12 0.01065 1.68454 1.942028 0.0521
13 0.01153 1.823051 2.298657 0.0215 13 0.01153 1.82305 2.236970 0.0253
14 0.01238 1.956895 2.563958 0.0103 14 0.01238 1.95689 2.500933 0.0124
15 0.01313 2.075553 2.773644 0.0055 15 0.01313 2.07555 2.711075 0.0067
16 0.01383 2.186987 2.954035 0.0031 16 0.01383 2.18699 2.892914 0.0038
* Probability approximation using studentized maximum modulus with parameter value 15 and infinite degrees of freedom
 Mishra: Analysis of Stock Market Efficiency 203

Appendix IV: Unit root test

Unit Root Test at level Unit Root Test at first Difference
Companies t-Statistic 1% level 5% level 10% level Prob.* t-Statistic 1% level 5% level 10% level Prob.*
ACEDBL -1.473 -2.598 -1.945 -1.614 0.131 -8.626 -2.598 -1.946 -1.614 0.000
BBC -0.556 -2.599 -1.946 -1.614 0.473 -8.129 -2.599 -1.946 -1.614 0.000
BOK 0.595 -2.584 -1.944 -1.615 0.844 -10.008 -2.585 -1.944 -1.615 0.000
BUDBL -0.917 -2.603 -1.946 -1.613 0.315 -7.987 -2.604 -1.946 -1.613 0.000
CEDBL -0.988 -2.610 -1.947 -1.613 0.285 -7.866 -2.611 -1.947 -1.613 0.000
CHCL 1.056 -2.592 -1.945 -1.614 0.923 -9.040 -2.593 -1.945 -1.614 0.000
EBL 1.014 -2.585 -1.944 -1.615 0.918 -13.625 -2.585 -1.944 -1.615 0.000
HBL -0.181 -2.585 -1.944 -1.615 0.619 -11.900 -2.585 -1.944 -1.615 0.000
ICFC -0.903 -2.600 -1.946 -1.614 0.322 -12.491 -2.600 -1.946 -1.614 0.000
ILFC -0.071 -2.592 -1.945 -1.614 0.656 -9.936 -2.592 -1.945 -1.614 0.000
KBL 0.051 -2.587 -1.944 -1.615 0.697 -11.737 -2.587 -1.944 -1.615 0.000
LICN 1.873 -2.585 -1.944 -1.615 0.985 -9.520 -2.585 -1.944 -1.615 0.000
NABIL 0.616 -2.584 -1.944 -1.615 0.848 -10.838 -2.585 -1.944 -1.615 0.000
NBB -0.300 -2.585 -1.944 -1.615 0.576 -13.607 -2.585 -1.944 -1.615 0.000
NDEP -3.507 -2.613 -1.948 -1.613 0.001 -8.827 -2.613 -1.948 -1.613 0.000
NEPSE 1.021 -2.584 -1.944 -1.615 0.919 -9.718 -2.585 -1.944 -1.615 0.000
NHPC -0.901 -2.599 -1.946 -1.614 0.323 -8.871 -2.599 -1.946 -1.614 0.000
NIB -0.062 -2.584 -1.944 -1.615 0.660 -10.476 -2.585 -1.944 -1.615 0.000
NLIC 1.747 -2.585 -1.944 -1.615 0.980 -8.955 -2.585 -1.944 -1.615 0.000
NTC -1.264 -2.605 -1.946 -1.613 0.188 -12.756 -2.605 -1.947 -1.613 0.000
OHL 0.770 -2.588 -1.944 -1.615 0.878 -9.978 -2.588 -1.944 -1.615 0.000
PLIC 0.301 -2.631 -1.950 -1.611 0.767 -6.726 -2.633 -1.951 -1.611 0.000
PRFL -3.234 -2.608 -1.947 -1.613 0.002 -10.938 -2.607 -1.947 -1.613 0.000
RIBSL -1.664 -2.612 -1.948 -1.613 0.090 -7.940 -2.613 -1.948 -1.613 0.000
SBI 0.646 -2.585 -1.944 -1.615 0.855 -10.161 -2.585 -1.944 -1.615 0.000
SCB 0.062 -2.584 -1.944 -1.615 0.701 -10.353 -2.585 -1.944 -1.615 0.000
SIL -0.203 -2.602 -1.946 -1.613 0.609 -9.288 -2.603 -1.946 -1.613 0.000
SUPRME -0.361 -2.613 -1.948 -1.613 0.550 -4.188 -2.615 -1.948 -1.612 0.000
UNL 3.583 -2.592 -1.945 -1.614 1.000 -7.368 -2.592 -1.945 -1.614 0.000
* MacKinnon (1996) one-sided p-values.