Universal Journal of Marketing and Business Research Vol. 1(2) pp.

072-78, June, 2012

Available online http://www.universalresearchjournals.org/ujmbr
Copyright 2012 Transnational Research Journals

Full Length Research Paper

Stock market efficiency in India: Evidence from NSE

Amalendu Bhunia
Department of Commerce, Fakir Chand College under University of Calcutta, Diamond Harbour, South 24-Parganas
West Bengal, India. Email: bhunia.amalendu@gmail.com; Mobile: +91-9432953985
Accepted 28 May, 2012

Market Efficiency has been a subject of main debate of traditional finance for a long period of time. It
emphasizes that security prices are rationally connected to many logical and psychological realities
and always incorporate all the information available to the market. In this way, security markets are
seen as efficient in reflecting information about individual stocks or about the stock market as a whole.
Market efficiency is in essence an extension of the zero profit competitive equilibrium condition from
the certainty world of classical price theory to the dynamic behavior of prices in speculative markets
under conditions of uncertainty. Risk and return is the core part in investment decision making
process. Risk-return tradeoff is the meaningful deciding point; this can be computed with the help of
capital asset pricing model. It is the best tool to measure risk and return content involved in the stocks.
In this study risk and return is calculated by using CAPM and attempts made to test the relationship
between risk and return is linear. Beta and necessary statistics models have been used for testing the
hypothesis framed for this study. This study evidence there is no strong efficiency found in the Indian
market.
Key words: Market Efficiency, Capital Asset Pricing Model, Weak form of EMH, Semi-strong form of EMH,
Strong form of EMH, Indian Capital Market, Beta
INTRODUCTION
In an efficient market all information pertaining to
individual scrip is assimilated immediately. The market
efficiency articulates how effectively the expectations of
investors are transformed into the stock prices. The
efficiency of the emerging markets assumes greater
importance as the trend of investments is accelerating in
these markets as a result of regulatory reforms and
removal of other barriers for the international equity
investments. The term market efficiency is used to
explain the relationship between information and share
prices in the capital market literature. Eugene F. Fama
(1991) classifies market efficiency into three categories
namely, weak form, semi strong form and strong form.
The distinctions among these three forms of efficient
market hypothesis are determined by the level of
information being considered. The security markets are
said to be in the weak form of Efficient Market
Hypothesis, if the current prices fully reflect all the
information contained in the historical prices and
consequently the investors are not able to consistently
earn abnormal profits by simply observing the historical
prices of securities. This form is popularly known as
random walk theory, which maintains that historical price

data have no predictive value. A market is semi-strong

efficient if stock prices instantaneously reflect any new
publicly available information and strong form efficient if
prices reflect all types of information whether available
publicly or privately. The objective of this study is to
review certain aspects stock market efficiency and it
implication on investment performance of equity shares
with some applications on security market in India.
Statement of Problem
Market efficiency is used to explain the relationship
between quantum of information and its impact in the
prices of securities in the capital market literature. An
efficient stock market is commonly thought of as market
in which security prices fully reflect all relevant
information that is available about the true value of the
securities. Market efficiency has several implications;
firstly, the share prices may not necessarily reflect the
true value of stocks. Low intrinsic value stock will
mobilize larger amount of capital whereas high intrinsic
value stock will find it difficult to raise large amount of

Bhunia 073

capital. This interrupts the investment activity of the

country including the total output in a particular period.
Secondly, it indicates changes in price of a share may
change in the expected returns of a security. Thirdly,
excess volatility caused in short-run because of more
reactionary pressure to new information. In a position of
market inefficiency, opportunities for supernormal profit
exist because the future prices can be predicted following
the strategies contained in past price movements. In an
efficient market, security prices reacts instantaneously
unbiased manner to impound new information in such a
way that leaves no opportunity to market participants to
consistently earn abnormal return. With the intention of
check investment performance of equity shares this study
has been made to test the market efficiency of NSE stock
for the period from January 2010 to June 2011.
Review of Literature
During the last five decades large number of tests on the
relevance and applicability of the random walk hypothesis
and efficient market hypothesis is carried out in many
leading economies. Fama and Macbeth (1973) tested
whether beta help explain returns and found the support
for capital asset pricing model. Ramachandran (1989) by
attempted 22 portfolio groupings based on beta and the
study found that the capital asset pricing model was
rejected. Fama and French (1987) found negative serial
correlation in the market returns over observations
intervals of three to five years. French and Roll (1988)
found significant negative serial correlation in daily
returns but suggested that it was small in absolute
magnitude and hard to gauge its economic significance.
Jagadeesh (1990) rejected the random walk hypothesis
because he found significantly positive higher-order serial
correlation in the monthly returns on individual stocks in
the United States over a period of fifty-three years.
Macqueen and Thorley (1991) rejected the random walk
hypothesis at higher levels of significance for post-annual
returns in the NYSE market for the period from 1947 to
1987. Dhankar (1991) concludes the Indian stock market
is efficient in the weak form. Gupta (1985) tested the
weak form of efficient market hypothesis for a recent
period, using data of five shares traded on the BSE and
concludes that random walk model is an appropriate
model to describe the equity price behavior India.
Penman (1982) examines the insider trading around
earning forecasting announcement. He found that
insiders buy shares before the announcement and sell
their shares after the announcement, by which they can
achieve high abnormal return. Therefore, insiders do
indeed have private information that is not impounded in
the stock price. Baumol (1965) makes an important
contribution to a better understanding of the performance
of the stock market. His book represents a synthesis of
past research and current thinking on the subject. It

analyses in considerable detail both the short-run and

long-run price equilibrating processes and points out
important departures from the competitive ideal and the
implications of these departures to stock market
efficiency. Besides, he offers his own hypothesis on the
pricing of securities, and he sheds new light on the
overall efficiency of the stock market as a mechanism for
allocating the nation ' s capital resources. Nalini (1999)
conducted a study on investment performance of equity
stock in Indian market. This study is tested empirically
with the capital asset price model, it analyses the
relationship between risk and return is linear or not.
Fama, Fisher, Jensen and Roll (1969) performed the
first test for semi-strong market efficiency. Using riskadjusted return to test for market efficiency with respect
to the announcement of stock split, they found a
considerable high abnormal return prior to the
announcement of stock split. Gupta (1990) in his book
has studied the working of stock exchanges in India and
has given a number of suggestions to improve its
working. The study highlights the' need to regulate the
volume of speculation so as to serve the needs of
liquidity and price continuity. It suggests the enlistment of
corporate securities in more than one stock exchange at
the same time to improve liquidity. The study also wishes
the cost of issues to be low, in order to protect small
investors.
Objective of the Study
The objective of the study is to test the market efficiency
by using CAPM model in the Indian Context. This
research work embattled to:
1.
Study the overall progress of Indian stock market.
2.
Check the growth of Indian capital market after
the establishment of NSE.
3.
Measure the relationship between risk and
expected return of a security.
MATERIALS AND METHODS
Sample and Testing Procedure
The present study is based on a sample of S&P CNX
Nifty index of National Stock Exchange, India. Capital
Asset Pricing Model has been tested by selecting 20
companies frequently traded in the market. The sample
companies are belonging to ten different industries. One
company each has been selected from diversified,
cement, communications and infrastructure sector. Two
companies each have been nominated from
pharmaceuticals, oil and gas, motor and banking sector.
Three companies have been selected from software and
five companies designated from electrical and power

074 Univers. J. Mark. Bus. Res.

Figure 1. S and P CNX Nifty Performance

Source: www.nse-india.com

generation sector.
The data set includes daily closing prices of the stock
beginning from January 2010 to June 2011. While
applying CAPM model, risk-free rate, market risk
premium and beta estimates are essential inputs
required. The risk-free rate is the return on a security that
is free from default risk and is uncorrelated with returns
from anything else in the economy. Put different, the
return on a zero-beta portfolio is the best estimate of the
risk-free rate. The risk premium used in the CAPM is
typically based on historical data. It is calculated as the
difference between the average return on stocks and the
average risk-free rate. As a market representative Nifty
index has been taken and returns for the stock as well as
index are calculated by using the following formula:
Rit = Pt+1 Pt / Pt
Where, Rit is return from the stock; Pt+1 is the current
price or todays price and Pt is the previous day price or
value. The same concept is also followed for calculating
the return from the market index.
Rmt = It+1 It / It
The returns are adjusted for the stock splits, bonus
shares, right issue and quarterly results and so on if any,
during the sample period. The beta of an investment i is
the slope of the following regression relationship:
Rit = i + it (Rmt) + eit
Where,
Rit = return on security i over a period of time t.
Rmt = return on the market portfolio in period t.
i = intercept of the linear regression relationship
between Rit and Rmt.
it = slope of the linear regression relationship between
Rit and Rmt.
In equilibrium the CAPM specified expected returns as
a linear function of risk in the form:
E (Rit) = Rit + [E(Rmt) - Rit] it

The beta co-efficient (it) is the function of

2
it = Cov (Rit, Rmt) / Rmt
Where, Cov (Rit, Rmt) is co-variance between the return
on assets and return on the market portfolio.
Testing of Hypothesis
The following hypothesis has been framed and tested
with the help of T-test and F-test.
1.
There is a linear relationship between the
expected return and risk in any efficient portfolio.
2.
The excess risk of any security will not be priced
by the market.
3.
The difference between risk-free rate and
expected return on market is equal to the slope.
Performance Analysis of Stocks
S and P CNX Nifty is the main index to the National Stock
Exchange. NSE was established in 1992 and trading
commenced only in 1994. NSEs management is vested
with the professionals appointed by the Government of
India. After the establishment of NSE, the trading activity
in the country is increased with the introduction of VSAT
trading facility. In addition to that improved transparency,
investors education, control on brokers, Demat, online
trading and ease of clearing and settlement captured the
attention of domestic as well as global investors.
With a view to measure stock market performance in
India, S&P CNX Nifty index has been selected as a proxy
to analyze market movement. It is easy to conclude from
figure 1, Nifty reached a new high in December 2007 with
more than 6100 points and subsequently sub-prime
problem in the US forced the market to come down

Bhunia 075

Figure 2. Growth of Indian Capital Market

Source: www.nse-india.com

2600 level in October 2008. Afterwards a sideways

movement was existed until February 2009. After that
there has been an uninterrupted improvement in market
triggered since liberalized economic actions taken by the
Indian Government. This trend was continued for nearly
one and half years up to December of 2010. In 2011
market movement was favorable for the bearish traders,
because the market is still under selling pressure from
the domestic as well as foreign institutional investors.
It is evident from figure 2, both market capitalization
and turnover slightly increased from 1994-95 onwards.
During this year, the market capitalization was Rs.
363350 crores and turnover Rs. 1805 crores. The trend
has been continued since 2000-01, market capitalization
stands at Rs. 657847 crores and turnover stands at Rs.
1339510 crores respectively in the same financial year. A
slight downward trend caused because of major
economic pressure in 2001-02 to 2002-03. Again the rally
was continued until 2007-08, both turnover and market
capitalization increased to new level of Rs. 4858122
crores and Rs. 3551038 crores respectively in the same
year. The major turmoil in US and some other countries
created big economic pressure in India in last quarter of
2007; it takes almost more than one year to recover
existing turnover and market capitalization in the capital
market. Currently this movement is continuing due to
liberalization initiatives taken by Federal Indian
Government. Many economic reform package and
stimulus helped the traders to execute more orders also
this paved the way for new issues and capital
appreciation in the existing value of shares.

EMPIRICAL RESULTS AND ANALYSIS

In order to test the risk and return pattern of sample
companies, the mean value of return and its standard
variation is computed. From table 1, it is clear that out of
20 companies studied, 11 companies have earned
handsome return than the market index Nifty, where as
other companies have earned returns which are lower
than the market. After that the risk condition is also
checked through computing standard deviation, 10 out of
20 companies risk is higher than the risk of the market.
Then the remaining companies risk is lesser than the
market risk. There is a positive relationship is expected
between the risk and return of a security. Higher the beta
for any security, higher should be the expected return.
But it is found that there is no relationship between risk
and return for eight companies. This may be resulted due
to misrepresentation of information presented to the
market participants. This study makes perfect; there is
non-linear relationship between the expected return and
risk in any efficient portfolio. It is not possible to individual
scrip to earn consistent return with index to a
considerable extent and at the same time scrip return is
always not affected by the market as well as non-market
risks. Risk can be eliminated by studying the timing and
technique of investment.
Table 2 reveals that at the 5% level of significance, the
null hypothesis has been rejected because table value
(2.23) is lower than the calculated t value. Hence, no
doubt the excess risk of any security will not be priced by
the market. Further the analysis clearly narrates; the
outcomes of F test advocates that the procedure used
here has done a superior work in the

076 Univers. J. Mark. Bus. Res.

Table 1. Risk and Return Performance of Nifty Companies

Company
ACC
Bharti Airtel
BHEL
Cairn
DLF
Dr.Reddy
GAIL
HCL Tech
Hero Honda
ICICI
M&M
NTPC
ONGC
Ranbaxy Lab
Reliance Ind
Reliance Power
SBI
Tata Power
TCS
Wipro
Nifty

Mean Value
2.56
2.07
-2.39
3.72
6.75
-3.32
-4.23
3.89
4.95
-0.87
2.17
-1.92
-2.12
-0.58
3.47
1.18
2.32
-0.36
2.74
-3.11
-0.11

Standard Deviation
7.12
5.96
12.42
11.17
13.49
8.51
6.27
5.98
6.11
8.42
9.31
10.22
16.24
5.72
7.01
6.45
7.56
14.79
7.54
8.16
7.90

valuation of security market line as calculated F value is

higher than the table value.
Analysis of risk-adjusted Performance Measure
The Sharpe Measure also known as Reward to Variability
Ratio indicates the excess return per unit of risk
associated with the excess return. The higher the Sharpe
Ratio, the better the performance.
SR = [r rf] / v
Where
SR= Sharpe ratio
r = Portfolio return
rf = Risk free rate
v = Portfolio volatility
Graphically, the Sharpe Measure is the slope of a line
between the riskfree rate and the portfolio in the
mean/volatility space. The Sharpe measure is closely
related to the t-statistic for measuring the statistical
significance of the mean excess return. The t-statistic will
equal the Sharpe Ratio times the square root of the
number of returns used for the calculation. It does not
refer to the market portfolio or any other benchmark.
Actually, the implicit benchmark is the riskfree rate of
return. The excess return can be interpreted as a zeroinvestment strategy: It can be obtained by taking a long
position in the portfolio and a short position in the riskfree
rate, with the funds from the latter used to finance the
purchase of the former.
The Treynor Measure also called as Reward to
Volatility Ratio also relates excess return to risk; but

Skewness
1.42
1.51
-0.07
0.35
0.47
2.11
0.74
0.43
0.67
1.39
-0.36
1.14
0.78
0.92
0.24
1.18
2.73
2.32
0.79
0.59
1.05

Standard Error
1.56
1.32
1.45
3.76
2.47
2.82
1.50
1.64
2.89
3.49
4.83
2.94
2.70
2.02
4.32
2.94
3.48
3.22
1.34
1.64
2.18

systematic risk instead of total risk is used. The higher

the Treynor Ratio, the better the performance under
analysis.
TR =[r rf] / b
Where,
TR = Treynor ratio
r = Portfolio return
rf = Riskfree rate
b = Portfolio beta
Treynor Ratio is graphically represented by the line
between the riskfree rate and the portfolio. Like the
Sharpe ratio, it does not quantify the value added of
active portfolio management. It is a ranking criterion only,
but it can be expected that portfolio managers which
possess private information will have a higher TR than
the TR of the uninformed market strategy. A ranking of
portfolios based on the TR measure is only useful if the
funds under consideration are sub-funds of a broader,
fully diversified portfolio. If this is not the case, portfolios
with identical systematic risk, but different total risk, will
be rated the same. But the portfolio with a higher total
risk is less diversified and therefore has a higher
unsystematic risk which is not priced in the market.
The Sharpe and Treynor Measures discussed above
can only be used in relative performance comparison
between portfolios and between a portfolio and a
benchmark. Jensen's Alpha measures the value added
by selection activities. Alpha is defined as the difference
between the average realized return of a portfolio
manager with private information and the expected return
of the passive strategy based upon public information
only with equal systematic risk.

Bhunia 077

Table 2. Beta Co-efficient of Nifty Companies (Significant at 5% level)

Company
ACC
Bharti Airtel
BHEL
Cairn
DLF
Dr.Reddy
GAIL
HCL Tech
Hero Honda
ICICI
M&M
NTPC
ONGC
Ranbaxy Lab
Reliance Ind
Reliance Power
SBI
Tata Power
TCS
Wipro

Constant
Value
2.59
2.11
-2.34
3.76
6.82
-3.29
-4.18
3.93
4.98
-0.84
2.21
-1.88
-2.09
-0.55
3.51
1.20
2.35
-0.05
2.76
-3.09

Beta Value
1.36
1.87
1.10
0.58
0.39
2.13
0.52
0.72
0.86
1.15
1.47
0.69
1.48
2.36
0.84
1.26
1.10
1.04
0.59
1.74

Correlation
efficient
0.37
0.53
0.28
0.34
0.78
0.49
0.91
0.29
0.30
0.84
0.46
0.67
`0.77
0.45
0.73
0.63
0.73
0.44
0.47
0.65

Co-

F-test

T-test

19.91
7.67
34.70
21.72
17.56
13.49
6.98
32.44
23.65
26.41
15.72
9.52
46.71
25.74
16.78
17.86
6.38
23.26
27.22
26.76

4.83
5.31
2.57
4.68
3.32
3.46
2.73
2.76
2.44
2.82
4.32
2.98
2.95
4.60
3.07
3.97
5.72
7.11
4.28
2.69

Table 3. Risk-adjusted Performance Measures

Company

Jensens Measure

Treynors Measure

Sharpes Measure

ACC
Bharti Airtel
BHEL
Cairn
DLF
Dr.Reddy
GAIL
HCL Tech
Hero Honda
ICICI
M&M
NTPC
ONGC
Ranbaxy Lab
Reliance Ind
Reliance Power
SBI
Tata Power
TCS
Wipro

-9.54
6.03
3.23
-1.19
-5.72
3.45
2.87
-7.87
-4.73
3.28
5.65
-2.02
-4.62
6.09
12.31
-0.23
-3.55
2.11
-6.74
-5.24

-5.92
-16.54
-17.29
-10.32
-12.43
-14.23
-7.85
-8.29
-3.94
-5.24
-20.24
-8.34
-5.23
-5.07
-4.23
-7.35
-7.93
-11.37
-14.27
-22.38

-0.98
-0.35
-1.24
-1.14
-2.45
-1.78
-0.45
-1.82
-2.21
-2.76
-1.19
0.63
-1.45
-2.33
-2.66
-1.59
-0.39
-0.12
-1.52
-1.43

JM = r [rf + b (r rf)]
The implementation of private selection information
means overweighing securities which have positive
Alphas. This means taking more unsystematic risk
compared to the passive strategy and results in a higher
total risk of the actively managed portfolio. Alpha does
not capture this increase in risk.

From table 3, according to Jensens measure the positive

Alpha values of eleven companies indicate superior
performance whereas other companies which have
expressed negative values. This negative value specifies
substandard performance of the company while
comparing with the market index performance. Again the
Treynors measures are higher than the benchmark for
the above companies and other have lower than the

078 Univers. J. Mark. Bus. Res.

benchmark indicating inferior performance over the

market. Both the measures presented above based on
only systematic risk and exclude unique risk of the
portfolio. Sharpe ratio attempt to study the total risk
associated with the portfolio. If the Sharpe measure is
larger, the performance of the portfolio is much better.
Now it is publicly known the Sharpe measure is higher in
case of 15 companies in the total of 20 samples and it
offered fair return than the market. Hence the investors
have been profited by taking extra risk in the investments
undertaken. Sharpes measure proposes that only five
companies have offered lowest return than the market
return.
CONCLUSION
The efficient market hypothesis has been widely tested in
the past few decades by many researchers and analysts
in the capital market of developed as well as emerging
nations. In spite of their innovative effort, the hypothesis
remains a debatable issue. The academicians and
market traders have not yet got unanimity about whether
capital markets are efficient or not. Thus, this paper
focused on testing the efficient market hypothesis in its
weak form in Indian stock market in the context of
investment performance of equity shares. This study
clearly gives the information regarding the growth of
Indian stock market. Both market capitalization and
turnover have been increased dramatically with the
liberalization initiatives taken by Indian Government for
the past two decades. By empirical evidence on Indian
stock market, there is positive relationship between the
expected return and beta of the security. In addition with
the intercept value with the risk free rate is matches well
in the sample period. It is clear from the above analysis,
return generated by the different companies are not equal
to the return generated in the stock market. From the
above analysis non-linearity risk-return relationship
existed in some cases because of more volatility in the
market. According to this study Indian market is not
strongly efficient.
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