Prices, expectations and the performance of the Indian stockmarket

Abstract

The recent rise in the importance of the Indian stockmarket as an avenue of investment for the household sector and a source of funds for corporations provided the primary motivation for this research effort: an investigation into the informational efficiency of the Madras Stock Exchange, one of the four major stock exchanges in India. A stockmarket is informationally efficient if expectations formation in the market is characterised by the rational expectations hypothesis. Direct observations of share price expectations, specifically collected for the purposes of this thesis, are used in the analysis to obviate inference problems associated with typical stock market informational efficiency test procedures. In general it is found that informational efficiency is not an appropriate characterisation of expectations formation in the market and that traders rely on rules of thumb to generate stock price forecasts. As such it is unlikely that the kind of speculative behaviour witnessed in the Indian stockmarket in the last 150 years can be entirely explained by expectations revision that correctly reflects the implications of major information changes. It is recognised that the structure of incentives faced by stock traders are such that it may not be worth their while to refine their forecasting procedures. Essentially as starting hypotheses to build further on the results presented in this thesis, the existing regulations and institutional arrangements in the Indian stockmarket are examined to see what form public intervention should take in order to make the market more informationally efficient.