Stock market volatility and weak-form efficiency, evidence from an emerging market

Abstract

An attempt has been made in this paper to model the volatility of stock returns and to test for weak- form efficiency for the Pakistani stock market, using daily closing prices from December 1998 to March 2006. The results point out that returns exhibit persistence and volatility clustering. Weak-form efficiency hypothesis is rejected as it is found that past information helps in predicting future prices. Mean variance hypothesis does not hold for Pakistani stock market as no evidence is found that investors are rewarded for taking increased risk. The impact of SECP reforms efforts, as captured by introduction of circuit breakers, has a dampening effect on return volatility, with a small increase witnessed in returns. Given the very small decline in return volatility, it seems that the policy impact can be characterised as neutral. Lastly, it is found that the 9/11 incident has led to an increase in returns and a decrease in returns volatility, which is in contrast to the widely-held conjecture that the 9/11 incident led to massive inflows of capital which were invested in the stock market, thereby influencing its volatility in a positive manner.