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RE- VISITING MARKET EFFICIENCY (EMH vs. FMH):

EVIDENCE FROM

INDIAN SHARIAH MARKET

First Author: Sania Ashraf P.P, Doctoral Scholar, Department of

Commerce, School of

Management, Pondicherry University, Puducherry, India:

605014.

Email id: [email protected]

Co-Author: Dr. Malabika Deo, Professor, Department of

Commerce, School of Management,

Pondicherry University, Puducherry, India: 605014.

Email id: [email protected]

10th International Conference on Islamic Economics and Finance

mailto:[email protected]

mailto:[email protected]

RE- VISITING MARKET EFFICIENCY (EMH vs. FMH): EVIDENCE FROM


Abstract

The paper evaluates the application of market efficiency theory propounded by

Fama and Mandelbrot. The study employs traditional as well as modern tools to detect

the efficiency in terms of Efficient Market Hypothesis and Fractal Market Hypothesis.

The work focuses on serial dependence or otherwise of Indian Shariah market i.e.

CNX Nifty Shariah, CNX500 Shariah and S&P 500 BSE Shariah during the period

spanning from 01/January/2008 to 31/December/2013. It was found that there existed

a serial dependence in the Shariah return series after employing the tools for Efficient

Market Hypothesis and the study found out that there existed Fractals in the market

and was traced out through tests like Hurst Exponent and Geweke Porter Hudak

Method. This leads to the inference that the market lacks efficiency and rejects the

Random Walk Hypothesis proposed by Fama. Hence, alerts the policy makers on the

predictability of the market even for short horizon which in principle should not exist,

as Shariah market is expected not to give opportunity for abnormal return.

Keywords: Shariah market, Efficiency, Random Walk Hypothesis, EMH, FMH,

Abstract


RE- VISITING MARKET EFFICIENCY (EMH vs. FMH): EVIDENCE FROM


Prelude

Risk, reward and catastrophes keep occurring in irregular cycles in the

financial world more specifically in stock markets. Greed, hubris and systematic

fluctuations have given rise to a series of crisis starting from Tulip Mania of 1637,

followed by South Sea Bubble of 1720, The Land Booms in 1920, US Stock Market

Crash of 1987 and recent Financial Meltdown of 2008. The ground reason for any

crisis in the stock market is the greed for higher returns leading to search for avenues

to make quick money exploiting the loopholes in the system that makes the market

extremely volatile. This volatile nature exposes the market to greater risk and

therefore provides reasons to look out for new and better strategies to manage risk.

Hence, a number of financial regulations, instruments etc. have been introduced to

ward off the unnecessary uncertainties in the market.

However, adoption of various trading strategies and techniques by smart

participants in the market complicated the market and such diversion were mostly

guided by speculation and trading unethically. Further, emergence of derivative

trading made the market vulnerable and exposed to furtherance of risk and

uncertainties and undue emphasis on one at the expense of another created misery for

a long run. Such intricacies evolved in the scenario disheartened many investor’s

bottom lines, who believed in idealistic approach of investing where otherwise would

have enabled them to increase both wealth and invest in companies that are socially

responsible and ethically viable. Hence the lookout for such trading strategies and

investments came in to action in a full-fledged way in form of a market based on strict

principles where focus was on ethics and morality. When the conventional markets

focused on risk transferring, the significant feature of this market was on risk sharing

between the parties. When interest and speculation run the conventional market, this

market focused on zero interest trading and no speculation.

The rules and principles of trading were farmed only after the catastrophe

occurs in conventional market but same is not the case with this market. The system

which prescribed well defined rules, strict trading behaviour and clearly specified

Conference paper (excluding author names and affliations)


products to be traded was nothing but the Islamic Financial system that existed in the

world but had limited recognition because of its misunderstood religious affinity. This

market is understood to have its origin form Arabia. Towards the end of the medieval

period, a man named Muhammad who at a very young age knew the importance of

honesty and honest practices in life and trade, bought out the calmness into the

chaotic Arabian tribes, and set way to the first financial system based on ethics,

human values, and justice. Today what is known as Islamic Financial system, evolved

from the Holy Book Quran (revealed in verses 2:275), was introduced to the world by

Prophet Muhammad (Peace Be Upon Him-PBUH).

Holy Quran has a satisfactory solution for all types of problems emerging, in

any situation any time and also provides all sorts of detailed answers even to socio

economic lives of mankind. The sayings of Quran purely promotes and encourages

trade and trade related activities but prohibits the involvement of interest in trading,

proscribe speculation and speculators and usage of double edged swords like

derivatives. Thus in long run saves the traders from the hands of breakdowns and

demolitions of market or market crashes having pervasive effect, at the same time

ensures protection of morality in investments. The off shoot of ethical economic

activities adhering the dictums of Quran is the Islamic Financial System with its

principles namely Shariah. Islamic Finance rests on the application of Islamic law

whose primary base is the verses of Holy Qur'an and the sayings of the Prophet

Muhammad (PBUH). Islamic Finance is a system that operates according to Islamic

law or Shariah. Shariah is a prescribed code of conduct or moral code which deals

with topics addressed by law including Crime, Politics and Economics as well as

Personal matters. Shariah in the context of Islamic Finance and trade, emphasises on

justice and partnership. The main principles related to trading under Islamic Finance

are such as:

Wealth must be generated from legitimate trade and asset-based investment. (The use

of money for the purposes of making money otherwise understood as speculation is

expressly forbidden.).

Investment should also have a social and an ethical benefit to wider society beyond

pure return. Risk should be shared equally.

All harmful activities (haram) should be avoided.


The origin can be traced to 1,400 years back, though the operation was

confined to those selected countries who believed in Shariah. Later, Islamic

Economics and Banking grew in its scope, making it to Islamic Finance where in

stock market activities also came in to its purview. It was not that very popular and

much talked about until its uniqueness was documented in the context of its risk

bearing capacity during Financial Crisis of 2008. Islamic Finance and its stock market

drew invariably everybody’s attention throughout the globe as it could wither the

onslaught of the vagaries of global financial meltdown, proving it to be relatively less

risky. The reason being the fundamental axiom of Islamic Finance and the system of

prohibition of debt-based financing and promotion of equity financing. For making a

stock eligible for trading in Shariah market a stock need to be from Shariah compliant

companies following the principles laid down by the Shariah Advisory Committee

strictly.

The guidelines laid down for making a company Shariah compliant are as follows:

a) Exclude businesses which involve in Alcohol, Pork-related products,

Conventional financial services, Entertainment, Tobacco, Weapons and

defence.

b) Conformity to the prescribed Tolerable Financial Ratios:

Debt to Market Capitalization should be <33%

Receivables of the company has to be <33%

Cash and interest bearing securities should be <33%.

c) Purify through charity by limiting impurity to 5% of income.

It is now estimated that worldwide around US$1 trillion assets are managed

under the rules of Islamic Finance. Over 75 countries have either started Islamic

Finance subsidiaries or converted their entire operations aligning to Islamic principle

i.e. to Shariah-compliant mode. The Islamic Financial movement was greatly

influenced by the establishment of the Islamic Development Bank (IDB) in 1973

which marked the revival of the Islamic Financial system. The recent debacle in world

economy causing global financial tornado that encircled the financial markets mostly

were one those were open and liberal in respect to mindless financial innovations,

transferring the risk through derivatives and other riskier financial products. As


Islamic Finance doesn’t open itself to the use of the same, it had the potential to ward

off the onslaught of the hazardous effect of unnecessary speculation and meltdowns.

The catastrophe of investment loss during Global Economic Crisis in the West has

forced the investors to search for safe and secure places of investment where Islamic

stock market has proved itself to be one. The Shariah markets also open the

investment avenue for those investors who believe in investment complying with

ethics, in other words the rule of Islamic Finance, especially those from the Middle

East who can pump in huge investment in to the country. The performance of Shariah

index caught attention of not only rich countries, who were impressed by the

performance, but also cash-stripped states who have showed interest in this fledgling

system.

A man’s greed never ends. Consequently, he is continuously in look out for

practices which will bring him more profit and reward for the money he has invested.

In this context, a smart investor or participant tries to find the opportunity where in an

abnormal profit can be earned and an ordinary investor wishes to get a reasonable

return and prefers a market where it is the investment that reaps return not the

knowledge, information, tactics or strategy adopted. Hence the first thing an Investor

perhaps does is the evaluation of the market and look out for safe profitable

opportunities. The investor always prefer a market which prices its product efficiently

and possession of any information by any market player do not put them in an

advantageous position so that abnormal profits can be earned. If information about the

market is not available appropriately and equally would bring in an opportunity for

some investors to take the advantage of the market. Such situation makes the market

vulnerable to inefficiency and helps the greedy investors to earn abnormal profit at the

cost of another. So a continuous look out for practices which will bring in abnormal

profits will be the first thing an investor perhaps would do. Thus finding out the state

of market, the opportunities it offers etc., has become the most interesting area of

research world across.

A detailed search for this particular phenomenon makes a stepping stone for

the most debated topic of ‘Random Behaviour of Stock Prices and Efficient Capital

Market’. There have been huge line of researches conducted across the globe to

identify the changing pattern of market prices starting from Bachelier’s (1900)

pioneering work on randomness of stock prices followed by Fama’s (1970) discovery


on Efficient Market Hypothesis leading to the theory of Fractal Market Hypothesis of

Mandelbrot’s (1971) projecting new dimension of market study diversing from the

application of EMH and finally Lo’s (2004) Adaptive Market Hypothesis where

predictability and investment profitability were said to differ from time to time thus

advocating the changing degree of efficiency in a vertical time scale. However, if an

investor expects the ethical nature of investment, then the market should possess

efficiency in terms of information available to him and such information should

sufficiently and promptly be reflected on the stock prices. It may be noted that studies

pertaining to efficiency were in plenty whereas, integrating researches of Fama’s

EMH, Mandelbrot’s FMH and Lo’s AMH to study price behavior in the stock market

were negligible. Of late, when there is an emerging alternative system which satisfy

the safety and ethical preference of investors there is a need for evaluate the market

behavior of such market.

Shariah market has proved to be a viable ethical investment, protecting the

investors and their investment from high unexpected market fluctuations that are

obvious in a conventional market which are heavily influenced by interest rates

prevailing in the economy. Moreover, with the concept of equal sharing of profit and

loss Shariah market boost the morale of the investors and can have a hassle free

investment. However, the awareness about such investment is lacking in India and is

far behind when compared to countries like USA, UK, Malaysia, Indonesia and some

Middle East Countries like Qatar, Kuwait, UAE and Saudi Arabia.

Though the seeds of Islamic Investment and Finance were present in the

economy since decades it got worldwide recognition only after the occurrence of the

bankruptcy of the ‘Lehman Brothers 2008 and series of fall outs in US and

consequent financial bankruptcy world over of 2008. Many a researches provided

evidence of better terms of return and volatility of Shariah markets even in the faces

of pervasive financial catastrophe. However, whether the market is strong and

efficient enough to offer a better avenue of investment providing opportunity of risk

management and portfolio optimization is a matter to be studied in-depth. Thus there

is a need for in-depth study in the performance, behaviour, characteristic strength and

weakness of the emerging alternative market i.e. Shariah market.


Background of the Study

There are ample number of theoretical and empirical studies on Islamic

Financial System across the globe. But empirical studies in Islamic Finance more

specifically Shariah index are limited and there are several untouched areas too.

Theoretically and empirically Islamic Finance and Shariah index were proved as out

performers during meltdowns. Pervez (1990), Chapra (1982), (1991), (1992), Shefrin

& Statman (1992) have theoretically explained how Islamic Finance can serve the

economy in a better way. Sam & Rashidian (2002) Obiyathulla (2004), Akhtar et al

(2010) and Bakri et al (2010) empirically proved that Shariah compliant shares are out

performers in terms of return to risk. In Indian context, Dharani & Natarajan (2012)

made an attempt on the ethical aspect of Indian Shariah market. Sania & Deo (2013)

proved that Indian Shariah market was predictable with macro-economic indicators

during the study period and necessary policy measures need to be taken to correct

those since Shariah principle prohibits speculation and abnormal profit. In terms of

the direction of the studies conducted earlier, majority of them focused on the

volatility nature of Shariah index but there were dearth of studies which focused on

sophisticated analysis of the behaviour of stock market in contrast to the conventional

one. Among them Market Efficiency or Informational Efficiency of Capital Market

which is a much debated one in conventional market was scantily tested for Shariah

market and exploring such a less touched area adds to the literature. In Modern

financial literature, Fama’s (1970) theory on Market Efficiency is treated as

foundation of all Capital Market Studies and majority of them revolve around its

implication on making the market efficient.

Though the concept of Market Efficiency was widely accepted some

researches highlighted on the dependence of current returns of stock prices on its past,

thus exposing the possibility of predictability of the market which were contrary to

market efficiency. As a starting line efficiency study can be incorporated for Shariah

market also, so to check whether the market is efficient in terms of market efficiency

theories or not.

In order to understand the concepts of market efficiency, its tools and

techniques applied from time to time a critical review on earlier studies reveal that the

first market behaviour study was the pioneering work of Bachelier (1900) where he


explored on the discounted returns of past, present & future of US stock market in his

doctoral research work. In the year 1953 Maurice Kendall a British Statistician

presented a paper to the Royal Statistical Society on the behaviour of the stock and

commodity prices. He concluded that Price changes were ‘Random’. Roberts (1959)

questioned the systematic patterns in US stock prices. These theories were not given

serious look till Fama introduced his concept of Market Efficiency and he introduced

the theory of EMH by segregating the behaviour of the market on the basis of Weak

Form, Semi-Strong Form and Strong Form Efficiency where he explained that Weak

Form of EMH is nothing but the reflection of all information with regard to current

prices over historical prices of a stock or a portfolio. In other words, the Weak Form

efficiency postulates current market price incorporates all the available information

related to the historical or past price. Since Weak Form Efficiency requires

independence of successive price changes as pre-condition, test of randomness and

serial correlation of stock returns were considered as the best indicator of efficiency.

Then researchers tried to focus highly on the random behaviour of the market. In

Semi-Strong Form, all the publicly available information are supposed to be in-

corporated in the stock prices and in Strong Form the information of Insider trading

expected to be incorporated instantly leaving no room for earning abnormal return and

no scope for prediction in the market, thus preventing investors any opportunity to

make abnormal profit by adopting any particular trading strategy. Though EMH

contradicted technical analysis and fundamental analysis it was always treated as one

of the strongest founding theories in Finance.

With the acceptance of EMH, finance literature got flooded with theories

supporting EMH, alongside the researches evidenced the anomalies of the same.

Some of the theories which favoured the findings of Fama were Cootner (1964),

Sharma & Kennedy (1977), Poshakwale (1996) & Pandey (2003) who supported the

theory of Weak Form Efficiency of EMH with different stock markets across the

globe.

It can be figured out from the studies that though many theories contradicted

and researchers found anomalies for Fama’s theory no one could out rightly corner

EMH and its validity except presenting evidences of anomalies only. The question of

“what if the market was not found efficient then what describes the market situation?”

existed for a long time. With that question, in the year 1982 Mandelbrot came up with


a new theory called Fractal Market Hypothesis (FMH) where he postulated that

fractals were found everywhere in nature and art and so also in the stock market

which can never be detached from the natural system and no market can be called as

efficient as postulated by Fama with respect to information prevailed in the market.

He claimed that there is a possibility of long memory in the market and possibly in

present returns there by will have reflections of past returns Mandelbrot (1971) &

Rogers (1997) claimed that trading strategies based on historical prices may prove

systematically profitable. Peters (1994) explained that market is stable and has

sufficient liquidity when it comprises of investors with different time horizon.

Investors stay in their preferred habitat no matter what the market information

indicates. Even when markets were stable it exhibit the same auto covariance

structure which represents Self-Affinity. The available information may not be

reflected in the market price, rather the market trend indicate the changes in expected

earnings.

As Shariah market doesn’t allow speculation and abnormal return in principle,

it is expected not to give room for such behavior to the investor by being efficient as

postulated by Fama. However, if the Shariah market is found to have long memory

then it violates the principle at the same time give room for speculation which

necessitates appropriate steps on the part of regulators to bring the market to state

where there will not be any scope for such unethical behavior that is against the

principle of Shariah. Studies never focused on the type of market behavior of Shariah

index. In Indian context. The intrusion of EMH and FMH in to studies in the area of

Islamic Finance and Shariah index would help the investors to understand the market

behavior and the efficiency in terms of information which helps them to take right

decision on time.

Model Specification and Methodology

The present study is exclusively based on secondary data, which were

collected from Bloomberg, National Stock Exchange Site (NSE) and Reserve Bank of

India (RBI) site. The period of study is from 31st December 2008 to 31st December

2013. The merger of Standard and Poor Index with BSE TASIS 50 to be named as

S&P 500 BSE Shariah on 31st December 2008 was the reason for selecting the data

range from 31st December 2008 in order to bring a linearity in the data. The indices


considered for the study were CNX Nifty Shariah, CNX 500 Shariah and S&P 500

BSE Shariah.

The study used traditional as well as modern analytical tools to analyse the

market efficiency in terms of EMH and FMH in the Indian Shariah market. The

closing prices of the indices were collected from the respective stock exchange sites

and were converted to returns as: 10

1

log t

t

t

PR

P

where log10 can give a

uniformity and reliability in the data.

For the purpose of tracing out the Weak Form Efficiency of Indian Shariah

returns the study Breush Godfrey LM test to detect the auto correlation in the return

series and KPSS test to identify the stationarity in the return series. The results of

FMH were retrieved through Hurst Exponent and GPH test.

Traditional Test for Weak Form Efficiency

Breush Godfrey LM Test

Coming to Breush Godfrey LM test, when compared to other auto correlation

test like Correlogram, Breusch Godfrey LM test covers up the pit falls faced by other

test which allows (1) nonstochastic regressors, such as the lagged values of the

regressand; (2) higher order autoregressive schemes; (3) higher order moving average

of white noise error terms.

The model specification is

where εt is a white noise error term. The study also employs KPSS test to identify the

stationarity in Shariah returns.

The Efficiency under Weak Form of EMH can also be checked through

detecting the Stationarity property of the returns. If the return series show stationarity

then the market is inefficient and if the series has a unit root then the market can be

called as efficient under Fama’s EMH theory. Thus to identify the stationarity of the

series the paper employed Kwiatkowski – Phillips – Schmit – Shin test.

1 2 21

.....t t t p t p t

u u u u


Modern Test for Weak Form Efficiency

Kwiatkowski – Phillips – Schmit – Shin test.

KPSS is the one of the most popularly used modern test to identify the Weak

Form of Efficiency of EMH in which the null hypothesis of presence of unit root is

tested against the stationary alternative. The alternative unit root test introduced by

Kwiatkowski – Phillips – Schmit – Shin (1992) has the null hypothesis of stationarity

of a series around either mean or a linear trend. The model takes the following form:

' t tttDy

where tD contains a deterministic components (constant plus time trend) t is

I(0)process which may be Heterosckedastic and t

is a pure random walk with

innovation variance 2

and the null hypothesis that t

y I(0) is formulated as

20 0

uH .

Traditional test for FMH

As per FMH, if a market has long memory it means that there is high auto-

correlation function which decays hyperbolically and dies out eventually, and if there

is a long memory in the market, it invalidates EMH proposition In order to detect the

long memory process, Hurst (1951) prescribed the procedure.

The study employs traditional tool of Lo’s (1991) Modified Rescaled Range

Analysis & Hurst (1951)’s Hurst Exponent and Geweke porter Hudak method to trace

out the results of FMH. HE is considered as the popularly used traditional method of

identifying the long range dependence.

Lo (1991)’s Modified Rescaled Range Analysis

Originally the procedure was based on the behaviour of the average range (R)

rescaled by the average standard deviation (S), as a function of sample size. For a

time series with total observations‘t’, there is an integer n, if n t then there exist the

R/S statistics and each range RIn is standardized by the corresponding standard

deviation SIn and forms a rescaled range as:


11 1 1

1( ( ) ( ( ) )max min

k k

k nk n t tn n

Rr t r t

n nS r r

where 2

1

1( ( ) )

n

nt

r tnn r

is the maximum likelihood estimated of simple

standard deviation.

Though the model R/S statistics captures the long memory dependence, later

on it was proved to have bias when (a) the series contains short memory (b) the series

is characterized by heterogeneity (c) the series is non-stationary. Hence Lo (1991)

modified the version of R/S statistics and named as Lo’s Modified Rescaled Range

Analysis.

The specification is as follows:

11 1 1

1( ( ) ( ( ) )

( )max min

k k

nk nk n t tn

Q r t r tn nq r r

where 2 2

1

( ) 2 ( )q

n x j jj

q q

,Error! Not a valid embedded object.

and q n . The value of n

q k where

21 33

2

3 2

2 1n

nk

where nk indicates the greatest integer less than or equal to &

nk is the sample

first order autocorrelation co-efficient of the data.

Hurst Exponent

Hurst Exponent (Harold Edwin Hurst 1880-1978) can be interpreted as a

measure of long memory of time series. It is a non-parametric approach which relates

to the autocorrelation of the returns in time series and at the rate which these decrease

as the lag between pairs of values increases. Peters (1994) suggested that financial

markets have a fractal structure: when markets are stable, returns calculated over

different time scales (daily, weekly) exhibit the same auto covariance structure. For


instance, if daily returns exhibit positive temporal dependence so do weekly, monthly

returns and this is termed as self- affinity.

The HE can be expressed as:

RLog

SHLogN

It is referred to as Index of Independence whose value lies between

0.5 1H indicating that high value in the time series will be followed by another

high value in the future series. (a) A value of 0.5H indicates a complete

uncorrelated series (b) 0.5 1H implies a persistent time series which can be called

a s Long memory process in the return series (c) 0 0.50H indicates that the time

series would be anti-persistent which implies that there will be a frequent mean

reverting process.

Advanced Modelling Technique for FMH

Geweke Porter Hudak (GPH) Method

Another tool to detect long memory property is the application of Semi-

Parametric tool of GPH propounded by Geweke Porter Hudak (1983). According to

GPH method, given the periodogram I s of variable

ty ,

can be estimated by the

following regression:

2ln( ( )) ln (4sin ( )s s s

I c

where I s is the periodogram of

ty at the harmonic frequencies

s . The

number of observations in the estimation of the regression is ( )n g T where ( )g T

should satisfy the following conditions:

( ) & ( ) / 0.lim limT Tg T g T T The function ( ) ,0 1g T T

satisfies both the conditions. The number of periodogram ordinates is chosen from the

interval0.45 0.60

[ , ]T T .


Results & Discussions

In order to evaluate the normality of the data series, descriptive statistics was

retrieved and the results are presented in table 1.1.

Table −1.1

Descriptive Statistics of Indices for the study period

Statistics CNX Nifty CNX 500 S&P 500 BSE

0.00025 0.026 0.00026

Std. Dev. 0.006 0.005 0.005

Skewness 1.173 1.117 0.9385

Kurtosis 19.443 19.789 17.802

JB (P-value) 1426.98* 1485.05* 1146.50*

*significance at 1% level at test statistics value of ±1.96

The descriptive statistics of the return series of CNX Nifty Shariah, CNX 500 Shariah

and S&P BSE 500 Shariah during 31st December 2008 to 31

st December 2013 showed

positive skewness and all the return series had leptokurtic distribution. The results of

Jarque Bera (JB) test show that the series is deviated from the normality. Thus the null

hypothesis of normal distribution of the series cannot be accepted, leading to the

inference that the returns were not normally distributed.

Test Techniques Applied and Findings of EMH

In order to detect the auto correlation of the return series the study used Breusch

Godfrey LM Test. To employ the results softwares like E-Views 7 and Gretl have

been used.


Traditional Test for Weak Form Efficiency

Breusch Godfrey LM Test

Table 1.2 presents the detailed results of Serial Correlation test for all the indices. For

the purpose of retrieving the cumulated result of auto correlation, the study uses

Breush Godfrey Lagrange Multiplier Test.

Table −1.2

Breusch Godfrey LM Test Results of Indian Shariah Index

Indices F-statistics

(P-value)

Obs. R2

(P-value)

CNX Nifty Shariah 1.7443** 61.517**

CNX 500 Shariah 1.617** 57.233**

S&P 500 BSE Shariah 1.684** 59.484**

** shows significance at 5% level

From the results, it can be noted that F-statistics is significant at 5% level for

all the indices considered for the study. Along with it, the observed R2

for CNX Nifty

Shariah, CNX 500 Shariah, and S&P 500 BSE Shariah were also significant at 5%

level which clearly reveals that the return series of Indian Shariah index were serially

correlated at 5% level of significance. This clearly rejects the hypothesis of Weak

Form Efficiency of EMH in Indian Shariah market.

Modern Test for Weak Form Efficiency

Unit Root Results

The study performed widely and popularly used Unit Root Test that is

Kwiatkowski–Phillips–Schmidt–Shin (KPSS). The optimal lag length was determined

by Akaike Information Criterion and MacKinnon’s Critical values were used in order

to determine the significance of test statistic. The results of the Unit Root are

presented in table -1.3.


Table−1.3

Unit Root Results of Indian Shariah Index

Indices

KPSS

t-statistics 5% sig

CNX Nifty Shariah 0.1887 0.7390

CNX 500 Shariah 0.2726 0.4630

S&P 500 BSE Shariah 0.2181 0.4630

It can be noticed from the above table that the results retrieved from KPSS

test, the results were significant at 5% level and the null hypothesis of presence of

stationarity in the series was accepted and hence it can be understood that all the

Indian Shariah Index under consideration don’t follow Random Walk Hypothesis of

EMH.

Test Techniques Applied and Findings of FMH

The estimation of results and diagnostic statistics were done after the

successful development of hypothesis and model specification. The basic test to detect

long range dependence or long memory property of financial time series was Lo’s

Modified Rescale Range Analysis and Hurst Exponent. The results of Lo’s Modified

Rescale Range Analysis (RSRA) has been shown in table 1.4.


Table−1.4

Results of RSR Analysis of Indian Shariah Index

SIZE

(Daily)

CNX Nifty Shariah CNX 500 Shariah S&P 500 BSE Shariah

RS

(avg)

Log

(size)

Log

(RS)

RS

(avg)

Log

(size)

Log

(RS)

RS

(avg)

Log

(size)

Log

(RS)

1242 42.70 10.278 5.416 50.90 10.27 5.669 52.05 10.278 5.702

621 26.45 9.2784 4.725 29.50 9.278 4.882 31.19 9.278 4.963

310 19.95 8.2761 4.318 21.19 8.276 4.405 21.27 8.276 4.411

155 14.33 7.2761 3.841 15.05 7.276 3.911 15.21 7.276 3.927

77 11.42 6.266 3.513 11.84 6.266 3.566 11.47 6.266 3.520

38 7.213 5.247 2.850 7.419 5.247 2.891 7.534 5.247 2.913

19 4.622 4.247 2.208 4.732 4.247 2.242 4.782 4.247 2.257

9 2.816 3.169 1.493 2.845 3.169 1.508 2.946 3.169 1.559

Hurst Exponent

Table 1.5 represents the results of Hurst Exponent for daily and weekly returns

of Indian Shariah Index. The results were checked to get self- affinity feature of the

returns by employing the test at different time scales i.e. daily returns and weekly

returns.


Table1.5

Hurst Exponent of Daily & Weekly returns of Indian Shariah Index

Hurst Exponent CNX Nifty Shariah CNX 500 Shariah S&P 500 BSE

Shariah

Daily 0.5270 0.5556 0.5581

Weekly 0.5442 0.5691 0.5581

The table 1.5 reports the results of Hurst Exponent of Indian Shariah index

with returns of daily and weekly time scales. It is clearly evident from the Hurst

Exponent that there is dependence in the returns of Indian Shariah index daily and

weekly and hence there is prevalence of self-affinity in the market. Thus the

hypothesis stating that there was no long memory in the market cannot be accepted as

value of H is more than 0.5 for Indian Shariah market during the study period.

The results of Hurst exponent show that the value of H exceeds 0.5 for CNX

Nifty Shariah, CNX 500 Shariah and S&P 500 BSE Shariah which clearly indicate

that there was a long memory in the returns of Shariah during the study period.

Advanced Modelling Technique for FMH

Geweke Porter Hudak (GPH) Test

The study used semi-parametric test of GPH to detect the long memory

property of Indian Shariah returns where the number of periodogram i.e. T

were0.5 0.6

,T T . Table 1.6 depicts the results of Geweke Porter Hudak Test of Indian

Shariah Index.


Table1.6

Geweke Porter Hudak Test of Indian Shariah Index

GPH (m=76)

Indices Degree of Integration

d=0

P-Value

CNX Nifty Shariah 0.1667

(2.0072) 0.0484**

CNX 500 Shariah 0.1824

(2.0471) 0.0442**

S&P BSE 500 Shariah 0.2872

(1.0653) 0.0290**

** significance at 5% level and values in parenthesis are t-statistics

It can be observed from the above table that the value for d in all the cases

were not equal to zero and all were significant at 5% level. The chosen bandwidth

range to conduct the test was0.5 0.6

,T T . Hence the null hypothesis of short memory

cannot be accepted and the degree of integration is not equal to 0.5.

Concluding Remarks

In this paper, an attempt was made to study the market behaviour of Indian

Shariah market in terms of its efficiency in line with the well acclaimed theory of

Fama i.e. EMH and the alternative theory suggested by Mandelbrot in the form of

FMH. After employing several statistical tools, the empirical evidences indicate that

the Shariah market was not efficient in terms of Weak Form Efficient Market

Hypothesis theory during the study period i.e. from 31st January 2008 to 31

st

December 2013. From the results of both traditional and advanced analytical tools of

Weak Form Efficiency it was observed that the returns of Indian Shariah market were

serially correlated and showed dependence during the study period. The results of

FMH indicated that the return series had a long memory dependence and hence the

market can be called as Fractionally Integrated market. From the analysis it was

concluded that the market had long memory and the trend of the market was

predictable during the study period.

The memory structure of the market indicated that there existed scope for

abnormal returns in the market. Thus leading to an inference that investors would


have earned abnormal profits in the past by reviewing the movements of the market.

As the results indicated that market lacks informational efficiency, there arises the

need of efforts to correct the same with appropriate policy measure at the earliest

because the reality found was contrary to principles laid down by Islamic guidelines.

Such inefficiency of the market could be due to the limited coverage of Shariah index

in India. Possibly, if the market was diversified well enough then the market would

have become efficient under EMH theory.

In order to enhance efficiency, financial authorities as well as Shariah boards

need to take appropriate measures to improve efficiency by making the market more

transparent and information flow more instantaneous. It is presumed that it will not be

much difficult to make the market efficient with appropriate measures because from

the results of Fractal Market Hypothesis it is noted that the value of Hurst is at the

brim of 0.5 which is near to efficiency of information and any step taken towards

making it more transparent can bring in informational efficiency in the Shariah

market.

Symmetric information will enable market participants to take decisions

quickly and appropriately, so those stock prices will rapidly develop an adjustment

mechanism which restricts the possibility of earning abnormal return among the

investors. Hence, information transparency is very important for Indian Shariah

market, as it can create a fair and a reasonable price in accordance with the real

condition of the company’s stock issuance.

The existing informational inefficiency gives the signal to the policy makers to

take cognizance of the reality i.e. the existence of scope for earning abnormal return

and take necessary steps to see that Indian Shariah index doesn’t violate the principles

of Islamic finance. This conclusion adds value to the existing literatures on Shariah

market and its efficiency.


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