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Institute of Management Technology, Ghaziabad

Dual Country Program

Business Research Methods

Are Indian Stock Markets driven more by Sentiments than Fundamentals?

Submitted By:

Akash Jauhari (DCP-056) Alok Kumar Mishra (DCP-057)

Karan Verma (DCP-072) Lokesh Chaudhary (DCP-075)

Raghav Agarwal (DCP-087) Varun Sehgal (DCP-092)

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TABLE OF CONTENTS

Introduction -------------------------- 3

Background -------------------------- 4

Research Gap -------------------------- 8

Research Objectives -------------------------- 9

Research Design -------------------------- 10

Methodology -------------------------- 11

Data Analysis -------------------------- 13

Statistical Tools, Interpretation and Conclusion -------------------------- 16

References -------------------------- 18

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Introduction:

The Indian Stock Markets are in a way the engines which drive the vehicle of our democracy by pumping in the much needed capital. Their behaviour and trends have intrigued many a scholar, many an analyst and many an investor. As time evolved, scholars and intellectuals propounded various theories and came up with different propositions with respect to the Stock Markets.

The Efficient Market Hypothesis claimed the rationale that fundamentals determine the market trends and that the market has 100% informational efficiency. This Hypothesis however came under severe criticism after the Wall Street Crisis of 1987. Investors & Analysts also suggested that actually there are certain Cognitive Biases that affect the stock prices. This school of thought, known as "Behavioural Finance", seemed even more authentic at times when the context was India. History is replete with instances when a high impact News elicited a knee jerk reaction from the investors leading to a slew of purchasing or selling decisions thereby affecting stock prices in an unexpected manner. However there were also instances where market fundamentals seemed to totally override any sort of emotional or sentimental wave.

The Indian Stock Markets are mainly affected by two E’s –

1. Earnings/Price Ratio – It is an important factor affecting the stock price of a company. It gives us a fair idea of company’s share price when it is compared to its earnings. The stock becomes undervalued if the price of the share is much lower than the earnings of a company. But if this is the case, then it has the potential to rise in the near future. The stock becomes overvalued if the price is much higher than the actual earning of the company.

2. Emotions/ Sentiments - They are a huge part of investing. Was it the case that only earnings drove the Indian Sensex to a high of 21,000 points in January 2008 and a low of 8700 points in October 2008? Not really. Emotions played a big part in both the rise and fall of the Sensex. When we get positive news about a company, it increases the buying interest in the market. On the other hand, when there is a negative press release, it ruins the prospect of a stock to increase in value.

It was this observation & inquisitiveness that led us to the question "Are Indian Stock Markets driven more by Sentiments than Fundamentals ". This research project is our quest to find an answer to this question which perhaps effects & intrigues every probable investor or trader in the various Indian Stock Markets.

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Background:

The Indian Financial Markets are one of the most developed and sophisticated capital markets in the world. Given the role of the Indian financial markets in propelling India’s economic growth, a proper understanding of the financial scenario becomes extremely critical.

The Indian Stock Market is one of the oldest in the world. There are two main stock exchanges:

1. Bombay stock exchange (BSE) – BSE is located on Dalal Street, Mumbai and is the oldest stock exchange in Asia. The equity market capitalization of the companies listed on the BSE was US $1.63 trillion as of December 2010, making it the 4th largest stock exchange in Asia and the 8th largest in the world. The BSE has the largest number of listed companies in the world. As of December 2010, there are over 5,034 listed Indian companies and over 7700 scrip’s on the stock exchange; also the Bombay Stock Exchange has a significant trading volume. The BSE SENSEX (SENSitive indEX), also called the "BSE 30", is a widely used market index in India and Asia.

2. National Stock Exchange (NSE) – NSE is also located at Mumbai, India. It is the 9th largest stock exchange in the world by market capitalization and largest in India by daily turnover and number of trades, for both equities and derivative trading. NSE has a market capitalization of around US $1.59 trillion and over 1,552 listings as of December 2010. The NSE's key index is the S&P CNX Nifty, known as the NSE NIFTY (National Stock Exchange Fifty), an index of fifty major stocks weighted by market capitalisation. NSE is the third largest Stock Exchange in the world in terms of the number of trades in equities. It is the second fastest growing stock exchange in the world with a recorded growth of 16.6%.

Though a number of other exchanges exist, NSE and BSE are the two most significant stock exchanges in India and between them are responsible for the vast majority of share transactions.

News Samples:

News flashing on TV or internet has an effect on the mood of investors. It has a fundamental component and sentimental component. Fundamentals basically include facts like EPS, PE ratio, Projects in hand, Expected cash flow and growth prospects. But as we generally observe, the sentiment component outperforms the economic factors. Here we

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state various instances where one can find unexpected changes in the stock prices of companies as reactions to some sensitive news.

1. Ambani Brothers Agree to Split India's Reliance Group.

By Ravil Shirodkar - June 18, 2005 05:35 EDT

June 18 (Bloomberg) -- Reliance Industries Ltd.'s founding members, the Ambani brothers, agreed to split the oil-refining, chemicals and cell phone group worth $19 billion, ending a seven- month ownership feud at India's largest non-state company.

Chairman Mukesh Ambani, 48, will retain control of the flagship, running oil, gas and chemicals, while younger brother Anil will take the power, cell phones and financial services businesses. Reliance shares have gained 12 percent since the dispute became public in November, lagging behind a 21 percent advance in India's benchmark Sensitive index. The stock, the fourth-worst performer in the index last year, yesterday rose 1.7 percent to 600.85 rupees, giving the company a market value of 839 billion rupees ($19.3 billion). The group, including unlisted units, had $23 billion of sales in the year ended March 2004.

2. Corporate News (livemint.com)

Cairn, ONGC get government nod for oil pipeline

Mumbai: Cairn India and Oil and Natural Gas Corp. Ltd, partners in the Rajasthan oilfields, have received permission from the government to build a pipeline to transport crude oil.

Cairn Energy India Ltd, operator of the fields and 70% partner in the joint venture, said that it has received a letter from the government granting the “right of use” for laying a 500km pipeline.

Given that Rajasthan crude is waxy in nature and needs to be kept warm for it to flow, the pipeline will be a heated one and is expected to cost around $780 million (Rs3,167 crore).

ONGC shares fell 0.46% to Rs828.30 each on the Bombay Stock Exchange on Tuesday, while Cairn’s shares were up 1.47% to Rs159.05 a share.

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3. ICICI Bank Share price fall due to bankruptcy rumors. Date: 29th September, 2008

ICICI Bank Share price have gone down by a whopping 14 percent on this day. This has led to serious "mail-rumors" running around across the various IT industry workers. Few weeks back, when Lehman declared Bankruptcy, people queued up at ICICI Bank ATM and Bank Branches to withdraw their money. Now again, the IT employees are getting worried on these rumors. The biggest cause of concern was that most of the employees are having their Salary account with ICICI Bank. That will mean that majority of the liquid earnings of the employees will be kept with this bank. Along with the ICICI officials, everyone hopes that this circus of rumors should come to an end. Savings bank account holders may not worry, as government will guarantee the return of their money in the savings account. In the past, around 4 years back, the GTB or Global Trust Bank had gone burst. It was later taken over by the OBC bank, a government run bank and all the savings account money was safe.

4. ICICI Bank is coming up with an FPO

ICICI Bank's FPO shares are about to list on the stock exchanges. The company entered the capital market on December 1 in the price band of Rs 505-545. The stock was issued at Rs 525 per share. It was issued at Rs 498.75 per share to the retail shareholders (The bank gave 5% discount to retail shareholders).

The issue closed on December 6. It was subscribed 6.78 times.

DSP Merrill Lynch and JM Morgan Stanley were the lead manager to the issue. Karvy Computershare was the registrar to the issue.

Date Open High Low Close Volume Adj Close

29-09-2008 565 569.9 483 493.3 5837100 478.99

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Date Open High Low Close Volume Adj Close 16-12-2005 560.8 596.95 557.2 587.8 1099200 545.23

5. Carrefour may infuse funds into Future Group: Sources Sat, May 23, 2009 at 17:47 Updated at Mon, May 25, 2009 at 09:12 Source : CNBC-TV18

Date Open Close %age change Open Close

%age change

5/26/2009 310 299.9 3.26 13929.84 13589.23 2.45 5/25/2009 301 309.1 -2.69 13988.1 13913.22 0.54 5/22/2009 299 300.35 -0.45 13663.54 13887.15 -1.64

The buzz is picking up in the market that Carrefour is again in talks with Kishore Biyani’s Pantaloon Retail. This time a deal may have already been struck. The new structure of Future Group entails that Future Fashion Merchandise, which would be a separate entity under the holding company Pantaloon Retail and under this will be the retail business subsidiaries for value and lifestyle retail. Carrefour has already announced its solo cash and carry plans for India. With Future Group, it could probably look at a backend support tie-up like a Bharti-Wal-Mart or also a financial partnership. But when we approached Biyani he refrained from commenting on this issue.

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Research Gap:

In the past, there have been a number of studies on the factors affecting the stock markets around the globe and what leads to the drastic changes in the stock indices. But no research has actually emphasised on the impact of sentiments/ emotions of the people on the stock prices and the stock markets in general.

Our research clearly aims to fill this gap and identify if the sentiments affect the Indian Stock Markets more than the fundamentals; something which has never been done before. We try to prove the same through qualitative as well as quantitative theories and statistical tools.

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Research Objectives:

1. To study the impact of Sentiments on prices of stock, on account of News as it appears in real time.

2. To compare the effect of Market Sentiments vis-à-vis the fundamentals of the industry and economy as a whole.

3. To quantify the above observations and apply statistical tools to test the stated hypothesis.

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Research Design:

1. Research to be Descriptive and Causal in nature. In order to interpret and understand the impact of sentiments of investors on the movements of the stock prices, tools like charts, graphs and tables are used. Also to test the hypothesis, statistical concepts are being used, based on their characteristics and distribution.

2. The research is an example of Field Study, where the study is conducted from outside, without interfering or manipulating the subject of interest.

3. The time frame considered is from April 2004 to February 2011, making it a

longitudinal data collection research. The time frame is critically selected in order to capture the Global crisis and its spill over to Indian Stock Markets.

4. Data Source is Secondary in nature. All the news flashes and articles are taken

from CNBC – money control website. Special care is taken so that accurate date of first flashing of news is incorporated in the study. The prices of stocks, beta values and SENSEX Index are taken from official website of Bombay Stock Exchange.

5. The units considered for research are individual Stock Prices. Selection of stocks

is based on their respective fundamentals like projects in hand, expected cash flows, EPS ratio and PE ratio. Impact of market sentiments on these strong and stable stocks is imperative to study as they form base of BSE index. Seven selected stocks are Infosys, TCS, L&T, RIL, ONGC, Pantaloons and ICICI.

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Methodology:

The entire procedure in course of the research can be divided into following steps:

1. Identifying News flashes From the selected portfolio of seven stocks, for the time period of April 2004 to February 2011, we selected about 46 news flashes. Care was taken to choose the news which is either entirely sentimental in nature or has a larger sentimental than fundamental component. The date of its first appearance is of utmost importance to us, since it creates reaction in the market in almost real time. Source of news was CNBC official website were precise time and date are also mentioned.

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2. Finding the change in stock for the particular day The reactions of investors to the new information are best displayed by the movement of stock prices. In many cases we observed abrupt changes in price, volume and number of transitions of the stock. As shown by difference of high and low of the day, one can clearly identify the market sentiments for the developments.

3. Estimating the actual and expected change Here Sensex is taken as a proxy for the fundamentals of the markets and economy. Beta for a stock is defined as the relative change of the stock with respect to Sensex. Thus the multiplication of the beta and Sensex gives expected change in the stock. Mathematically the above relations can be given by –

Actual % Change in Stock Price = ((closing – opening) * 100) /opening.

Expected % Change in Stock Price = (Beta) * (% Change in Sensex).

4. Comparing the two data sample over the period of time

We obtain the two samples of data – actual and expected changes in stock prices. The comparison includes Beta values which gives the expected change on the basis of regression of past 10 years (calculated by BSE) vis-à-vis the actual/ observed change in prices as shown on the markets. Appropriate statistical tool is chosen based on the characteristics and distribution of the two samples.

5. Interpretation and Conclusion Testing the hypothesis using statistical tools and getting to a result enabled us to interpret the movement of stock prices on account of investor sentiments vis-à-vis the fundamentals of the concerned company. Also, showing the result through charts and tables helped to further understand the findings of the research.

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Data Analysis:

The following table shows the changes in the stock prices of TCS on account of speculative news on given dates. For every date of interest, the stock prices and the sensex of one day before and one day after are also considered. This is because leakage of news may come into play one day before and spill over effect may continue over the next day as well. The percentage change is calculated by taking the relative difference between day’s closing and day’s opening.

TCS

Date Open High Low Close Volume Adj Close

Actual Change

2/12/2009 518 518 503.9 509.2 142200 496.25 -1.70 3/12/2009 450.25 484.7 450.25 475.3 201600 463.21 5.56 3/13/2009 453.35 508.85 453.35 506.55 273800 493.67 11.73 3/16/2009 507 522.5 502.1 519.8 236900 506.58 2.52 4/8/2009 550 612 550 604.8 227500 589.42 9.96 4/5/2010 814 814 799.35 802.6 240700 795.1 -1.40 4/6/2010 804.8 805 791.35 794.75 249000 787.33 -1.25 4/23/2010 730 792 730 779.8 319000 772.52 6.82 6/9/2010 752.5 757 732.9 735.15 363700 728.28 -2.31 7/8/2010 770 778.55 769 776.6 146400 773.31 0.86 2/2/2011 1159 1195.95 1159 1178.9 211400 1178.9 1.72 2/4/2011 1183 1183 1141 1148.1 180200 1148.1 -2.95 2/15/2011 1115.95 1116 1077.35 1096.8 232600 1096.8 -1.72 2/16/2011 1104.75 1110 1081.15 1098.3 133900 1098.3 -0.58

The value in the last column indicates the actual change in the stock price.

The table below gives the percentage change in the Sensex for the same dates. This percentage change when multiplied by the beta factor gives the expected or theoretical change in the TCS stock, based on regression of last 10 years. Thus the two columns of actual and expected change can be compared on head to head basis.

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BSE

Open High Low Close %Change

Expected Change

9559.03 9580.13 9445.54 9465.83 -0.97 -0.82 8274.78 8439.71 8274.78 8343.75 0.83 0.70 8480.74 8793.21 8480.74 8756.61 3.25 2.73 8793.89 8955.73 8697.46 8943.54 1.70 1.43 10283.58 10778.11 10171.91 10742.34 4.46 3.75 17693.66 17948.54 17693.66 17935.68 1.37 1.15 17940.32 17991.41 17898 17941.37 0.01 0.00 17533.88 17725.88 17533.88 17694.2 0.91 0.77 16621.12 16817.69 16591.26 16657.89 0.22 0.19 17536.48 17728.37 17536.48 17651.73 0.66 0.55 18216.91 18306 18042.61 18090.62 -0.69 -0.58 18450.07 18542.2 17926.98 18008.15 -2.40 -2.01 18260.08 18361.66 18050.48 18273.8 0.08 0.06 18273.06 18358.84 18216.12 18300.9 0.15 0.13

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Graphical Representation:

Graphical representation of the actual vis-a-vis expected movements in the TCS stock price is shown below.

X-axis = dates of interest Y-axis = magnitude of change .

The above graph shows the variation in Actual Change (colored blue) and Expected Change (colored red) in the TCS stock price, with the magnitude of change on the Y- axis and dates of interest on the X-axis. Each number on X-axis corresponds to a date of observing the movement, which can be matched to data file. It can be clearly observed from the graph that the fluctuations in Actual Change are much higher or amplified as compared to the Expected Change. Here it is important to note that the blue line shows the movements due to sentiments and red line is a proxy for the macro or more fundamental developments. Thus on the given day of speculative news, the impact of sentiments on the market (given by blue lines) is greater than impact of fundamental factors (given by red lines).

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14

actual change

expected change

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Statistical Tools, Interpretation and Conclusion:

From the seven individual stock data sheet in excel, we export data to SPSS. Here we combine all the 46 news flashes with their respective changes and fluctuations. This can be seen in attached file named – data sheet.sav. Now we have two samples – expected and actual, and the difference between them.

According to our research model, we consider the null hypothesis as “The impact of fundamentals on stock market is greater or equal to impact of investor sentiments”. Thus the alternate hypothesis becomes “impact of Investor sentiments on stock market is greater than that of the fundamentals”. Difference is defined as the entry of estimated change and actual change in stock prices.

Ho = Mean of the difference of the sample is greater than or equal to zero. In other words impact of fundamentals is more than sentiments.

Ha = Mean of the difference of samples is less than zero.

We apply the - One sample, one tailed test

After running the statistical tool, following results are obtained:

One-Sample Statistics

N Mean

Std. Deviation

Std. Error Mean

Difference 46 -.3461 3.03282 .44716

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Here we can see that there are total 46 entries, mean of actual sample is greater than mean of expected sample by 0.3461. Standard deviation of the sample of difference is 3.03.

One-Sample t-Test

Test Value = 0

T df Sig. (2-tailed)

Mean Difference

95% Confidence Interval of the Difference

Lower Upper

Difference -.774 45 .443 -.34609 -1.2467 .5545

Now we get the significance value as 0.443, which is for two tailed test. To convert it into one tailed test, we apply following relation.

P-value (one-tailed) = (P-value (two-tailed)/2) ^ 3

Which implies P-value (one-tailed) = 0.0108

Thus at alpha = 5% or 0.05, we get P-value (one-tailed) < 0.05

Which implies that Null hypothesis is rejected.

Which implies that mean of the difference of sample is less than zero.

Hence we can conclude that the impact of Investor sentiments on stock prices is greater than that of the market fundamentals.

Thus our observation that the Indian Stock Markets are driven more by emotions and sentiments rather than reasoning, logic and fundamentals is supported and eventually proved by the statistical analysis.

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References:

1. www.bloomberg.com

2. www.moneycontrol.com

3. www.bseindia.com

4. http://in.finance.yahoo.com/

5. http://news.google.co.in/nwshp?hl=en&tab=wn

6. www.investopedia.com

7. www.economictimes.com

8. http://money.rediff.com/