RANDOM WALK AND INDIAN EQUITY FUTURES MARKET

Kapil Gupta Research Scholar, Department of Commerce and Business Management, Guru Nanak Dev University, Amritsar 143005, Punjab, India. Email: Kapil_asr1@rediffmail.com Dr. Balwinder Singh Reader, Department of Commerce and Business Management, Guru Nanak Dev University, Amritsar 143005, Punjab, India. Email: bsssaini@yahoo.com ABSTRACT The present study investigates weak form of efficiency in Indian equity futures market. For this purpose, informational efficiency of the Nifty futures and 24 stock futures is examined. The Nifty and stock futures returns are found to be deviating from normal distribution. The futures prices are found to be nonstationary at levels whereas, first difference futures returns are stationary. Empirical analysis finds evidence of statistical dependence in the returns generating process. Further analysis through Autoregressive Integrated Moving Average (ARIMA) process reveals that the Nifty and stock futures returns are not independent and shows strong dependencies. SECTION I. INTRODUCTION The professional stock market analysts and the academic statisticians hold contradictory view on the price behaviour in speculative markets. The professional analysts believe that there exists certain trend generating facts, knowable today, which guides a speculator to earn super normal profit, provided he is able to read them correctly and timely. These facts are believed to generate trends rather than instantaneous jumps because most of the traders in the speculative markets have imperfect knowledge of these facts, and the future trend of prices will result from a gradual spread of awareness of these facts throughout the market. Those who read information earlier than others will have an opportunity to secure super normal profit. Two main schools of professional analysts, the fundamentalists and the technicians , agree on this basic assumption. The only difference lies in the methodology to read the information early (Alexander, 1961). The fundamentalists seek early knowledge by studying the external factors that cause the price changes. In a commodity market, they try to forecast the prospective demand-supply equilibrium. Whereas, in the stock market, they study general business conditions and the prospective earning profile for various industries and individual firms within those industries, with special attention to new developments. The technical analysts too operate on the same basic assumption that facts existing at one time will govern the prices at some future time, but their modus operandi is different. They leave to others the study of the fundamental facts, in the belief that as others act on their knowledge, there will be a detectable effect on the price of the stock or commodity. The technical analysts accordingly, study price movements of the immediate past for telltale indication of the price movements in the near future. In this way, both schools of analysts assumes the persistence of trends, which represents the gradual recognition by the market of emergent factual situation trends which, if they exist, must depend for their existence on the lagged response of the market prices to the underlying factors governing these prices. It might, at first blush, seem possible that the trends arise not from a lagged response of the market price to the fundamental circumstances, but from a trend in those underlying circumstances themselves (Working, 1934). Consequently, if there is no lagged response, there should be no trend in prices. The professional analysts would certainly not subscribe to the notion that the best picture of the prospective price movements can be gained by tossing a coin or a set of coins, though it is just what the academic students of speculative markets say is the best way. The academic students of speculative

markets deny the very existence of trends in speculative prices. They claim that where trends are observable, they are merely interpretations, read in after the fact, of a process that really follows a random walk (Fama, 1965 and 1966). A price movement can be characterized as random walk, if at any time the expected change can be represented by the result of tossing a coin, not necessarily a 50-50 coin. In particular, random walk would imply that the next move of the speculative price is independent of all past moves or events (Bachelier, 1900 and Nordhaus, 1987). Fama (1970) inferred that random walk model does not refute the relevance of past information in assessing distribution of future returns. He stated that since return distributions are assumed to be stationary through times, past returns are best source of such information. Further he inferred that random walk model says that the sequence (or the order) of the past returns is of no consequence in assessing distribution of future returns. Fama recognized that a speculative market would be characterized as efficient in weak form, if it satisfies the following conditions: (i) There are no transaction costs in trading securities, (ii) All available information is costlessly available to all market participants, and, (iii) All agree on the implications of current information for the current price and distributions of future prices of each security. Fama stated that although there may be other factors responsible for market inefficiency but the above stated conditions are potential sources of market inefficiency. Because all three exists to an extent in real world market and measuring their impact on the process of price formation is the major deal of empirical work in this area. One of the speculative markets gaining popularity both in the developed as well as developing economies is the equity futures market. In India, the equity futures are actively traded on Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). Since futures offer the traders an opportunity to hedge their risk exposure to the underlying asset, it has become the favorite instrument for most of the traders (investors, arbitrageurs, speculators and hedgers). At the beginning of the contract, the difference between the futures price and spot price (i.e. Basis), would be more and as soon as the expiry date comes closer, the spot prices converges into the futures prices (Kamara, 1990 and Dorfman, 1993). Telser (1981) studied the rationale of organized futures market and found that the futures markets have been efficient. Kawaller et al., (1987) and Chan (1992) implying that futures market represents the forward price of the underlying asset, found significant lead-lag relationship between the futures market and the spot market. Granger (1998 and 2000), Booth et al., (1999) and Singh (2001), also found significant cointegration in futures and spot market prices. Thus, Price discovery is considered to be the pivotal role of an efficient futures market. This feature of the futures market guides the trader s behavior. Thus, if price discovery is true, positive futures movement implies bullish sentiment in underlying asset market and vice versa. Brannen and Ulveling (1984) compared how well current spot prices predict future spot prices for a variety of commodities in a non-futures market environment and examined how the predictive power of the price system was altered in the post futures trading introduction era. They observed the spot market was not a good predictor of prospective spot market prices. However, they found strong evidence that the futures market was a good predictor of prospective spot prices. Thus, they recommended that futures is an effective price discovery vehicle. The futures market can be said to be efficient only if the current futures prices reflect all information (i.e. information based on the events that have already occurred and on events, which as of now the market expects to take place in the future) and the historical price movements do not have significant impact on current and future price movements. Thus, futures price movements should have lagged correlation coefficient close to zero. In other words, the efficiency of futures market in weak form is a primary condition for futures to be an efficient price discovery vehicle. Weak form efficiency of futures market implies that no arbitrage opportunities persist in the futures market (Singh, 2001).

The current paper is an attempt to examine weak form efficiency of Indian equity futures market. In order to study weak form of efficiency in the Indian equity futures market the current study is divided into five sections. First section covered introduction, second section reviews the literature, third section discusses database and methodology, section fourth analyses the data and finally, in section five conclusions have been drawn. SECTION II: LITERATURE REVIEW The history of the financial mathematics and the study of random walk dates back to the beginning of 20th century, when Bachelier (1900) submitted his Ph. D. thesis. He surprised everybody with his results. He found Brownian motion in stock prices, implying that stock price movements are random and does not follow any systematic patterns. Following Bachelier s study, Cowels (1933) attempted to study the behavior of stock market prices and he supported the findings of Bachelier. Evaluating the portfolios of institutional investors (i.e. 20 fire insurance companies, 16 financial services and 24 financial publications engaged in publishing forecasts on the basis of past trends), he found that their returns were higher than the return of a normal investor but were poorer than the returns from an outright investment in representative stocks for the period. Further, Cowels (1933) evaluated the investment strategy of William Peter Hamilton [1] over a period of 26 years (1904-1929) and found his returns were far lower than that of market returns. Examining the portfolio of 20 fire insurance companies and 16 financial services, which prepared portfolio on the basis of trend-based theories [2], he concluded that since patterns are missing, hence, technical theories are of no use [3]. Kendall and Hill (1953) made an impressive attempt to study the behavior of stock market price changes. They calculated the first twenty-nine lagged serial correlations of the first difference of twentytwo time series representing speculative prices. Nineteen of them were indexes of British Industrial share prices on a weekly basis. Two of the remaining three was cash wheat at Chicago, one weekly and one monthly, and the last one was the spot cotton price at New York, monthly. Contrary to the general impression among traders and analysts that stock and commodity prices follow trends, Kendall suggested that knowledge of past price changes yield no information about future price changes and in speculative markets, history does not repeat itself. The findings of Working (1934) and Alexander (1961) were consistent to that of Kendall with few variants. Working (1934) stated that a series obtained by cumulating random numbers, will for brevity and clarity be called usually a random-difference series, since it is the first difference of the series and not the series itself, which are random number. The only limitation of his study was the lack of force, which was later provided by Kendall through the extensive study of lagged price response. Further Alexander (1961) quoting the study of Kendall (1953) and Osborne (1959) stated that in an efficient speculative market, the price movements are random. But he holds the view that price move, once initiated tends to persist until the market reverses by same proportion. He was of the view that if Filters test is applied, it will give more accurate results regarding future price movements. Alexander, observed that if the stock price has moved x percent, it is likely to move up more than x percent further before it moves down by x percent. Defining the random movements in stock markets, he observed unbiasedness in stock price movements. Mandelbrot (1966) presented the Martingale model, implying that price series may not be random but its unbiasedness property does not allow the traders to exploit price dependences to secure super normal profits. Smidt (1968) denying the complete absence of systematic elements, stated that investigations of the random walk hypothesis would be most fruitful if they were conducted in the spirit of attempting to determine the size and extent of systematic tendencies that may exist in price series. Even if the largest part of a sequence of price changes may be described as following a Martingale process, it is the remaining systematic components that may be more critical. LeRoy (1989) and Roll (1994) observed that it is remarkably hard to make profit even from the most extreme violations of market efficiency. Cootner (1962) inferred that price movements in the speculative markets are found to be random and the return in these markets tends to be significantly confirming leptokurtic distribution. He investigated the efficiency of the stock market in NYSE. Applying the Mean Square Successive Difference test, he concluded that the price movements are systematic and he found very weak evidence of

randomness. Fama (1966) in his discussion paper stated that since the returns are more skewed and the kurtosis is relatively higher in speculative markets, the returns do not confirm to normal distribution. Speculative market returns may follow either platykurtic or leptokurtic distribution. Stevenson and Bear (1970) while studying commodity futures price behavior at Chicago Board of Trade (Corn and Soyabean) for 1951-1967 also found the futures returns confirming to the leptokurtic probability distribution however they witnessed a very weak evidence of random walk in price movements. They found long-term segments profitable under mechanical trading patterns throughout the time period covered both in an absolute sense and with respect to buy-and-hold policy. Kamath R. R. et al., (1998) examined SET index and 10 industrial indices in stock exchange of Thailand over a period of 15 years and found that the index movements confirm to leptokurtic distribution. Evans (1968) studied price movements of 470 securities listed in Standard & Poor Index over a period of 1958-1967. Applying the filter rule, he found that irrespective of the degree of randomness or form characterizing the empirical distribution of security price changes, employment of Fixed Investment Proportion Maintenance strategy yields returns which are significantly superior to those yielded by a naive buy-and-hold strategy. Further he found that although some degree of non-randomness exists in the distribution of security price changes, it is not of a magnitude that should be considered meaningful to the investor dealing with portfolio of securities. Fama (1965) made comprehensive study of the stock price movements and observed strong evidence of random walk. He evidently stated that the stock price movements are independent and the returns of the stock prices confirms to the leptokurtic distribution. Jensen and Benington (1970) studied 1952 securities listed on NYSE over a period of 1926-1966 to find out the relevance of technical theories. Examining Buy-and-Hold policy and the mechanical trading rules, they concluded that the behavior of security prices on NYSE is close to that predicted by the efficient market theories of security price behavior. Fama (1970) presented a comprehensive literature review on efficient market hypothesis and categorized the informational efficiency in three categories i.e. Weak form efficiency, Semi-strong form efficiency and Strong form efficiency. In this way, he clarified that if the stock prices show no lagged response, it implies that all historical information and information related to the foreseen events has already been impounded in the current stock prices and the market is efficient in weak form. If the stock prices are found to be sensitive to public announcements, market will be efficient in Semi-strong form. However, if the company directors have any information, which may affect the future price movements, and it is not disclosed, market sensitive to such information will be efficient in strong form. In this way, Fama categorized the informational efficiency of the speculative markets. Rendleman and Carabini (1979) examined the efficiency of the Treasury bill futures market in CME during 6th May 1976 and 31st March 1978. Applying autocorrelation test they found quasi-arbitrage opportunities prevalent in the Treasury bill futures market that indicates market inefficiency. They stated that these potential arbitrage returns were worth exploiting, given the indirect costs of educating traders and policymakers within financial institutions, the cost of monitoring the futures market, the inability to cover future obligation with the exact Treasury bill required, and the reluctance by many financial institutions to alter the present maturity structure of their short run portfolios. Rauser and Carter (1983) also held cost element responsible for futures market inefficiency. Applying ARIMA, x2, t, Mean Square Prediction Tests they found that the multivariate and ARIMA models outperform the futures markets for Soyabean and Soyabean meal but not Soyabean oil for both long-term and short-term horizons. Following simulations, they found the existence of arbitrage opportunity in Soyabean complex. Kumar and Makhija (1986) examining the efficiency of non-stationary stock price time series contradicted the Shiller s (1981a) results. They stated that non-stationary time series confirms to the Efficient Market Hypothesis. Dorfman (1993) applying Bayesian Monte Carlo Integration Technique on commodity futures price movements in Chicago Mercantile Exchange found that the futures price series was stationary and futures prices series did not confirm to efficient market hypothesis. Brown and Easton (1989) conducted study in the London Stock Exchange using daily data ranging between 1821-1860. The objective of their study was to study whether in the historical periods London stock market was efficient. Using serial correlation, runs test and x2 they found that the London market was efficient in the historical time period as it is evidenced in the contemporary markets. They found the price

movements were independent and found serial correlation coefficient close to zero. Dokko and Edelstein (1989) applied same set of statistical techniques in Livingstone stock market using data for a period ranging between 1955-1985 and found that the Livingstone stock market forecasts to be adaptive and the stock prices follow random walk. Chen Ping (1996) using autocorrelation, spectral analysis and filter techniques studied the price movements in FSPCOM (S & P 500 Stock Price Composite Monthly Index) and FSDXP (S & P Common Stock Composite Dividend Yield). He found that 70% of fluctuations in S & P stock price Indexes, detrended by filter, could be explained by deterministic color chaos. The characteristic period of persistent cycles found to be three to four years. They reported correlation dimension about 2.5. They suggested the existence of persistent chaotic cycles revealing new perspective of market resilience and new source of economic uncertainties. Since large part of the sample understudy could be explained by color-chaos model of business cycle thus, he concluded the non-existence of random walk. Most of the studies conducted in the developed markets confirm to weak form of efficiency, whereas reverse is the case with developing and the less developed markets (Mobarek and Keasey, 2000). Reddy (1997) investigated the evidence of Efficient Market Hypothesis in Indian stock market. Using ARCH and GARCH methodology he found no evidence of efficiency in Indian stock market. In India he found, stock market returns do not confirm to normal distribution, which implies that price movements are speculative and volatile. He held low speed of information dissemination, the cause for Indian stock market inefficiency. Kamath R. R. et al., (1998) also observed significant day-of-the-week effects in Thailand stock market. Mishra (1999) and Anshuman and Goswami (2000) examined the day-of-the-week-effect in Indian stock market and found that weekday anomalies persist in Indian stock market. Ranjan and Padhye (2000) found that the return distribution to be uneven across the week. They observed lowest return on Friday, whereas, Wednesday witnessed highest return. Mangala and Mittal (2005) also found daily closeto-close returns to be most negative on Friday and most positive on Wednesday. They inferred that anomalies prevalent in Indian stock market indicates market inefficiency, implying that trader can design his buy and sell strategy and can exploit this situation to secure extra profits. Mobarek and Keasey (2000) attempted to study the behaviour of stock price movement in Dhaka Stock Exchange in Bangladesh for a period 1988-1997. Applying runs test, autocorrelation test, autoregression test and ARIMA model they reported market inefficiency. They held longer processing time, huge transaction cost, inefficient communication system and low volume of trade may be the reason for inefficiency in the market. Pant and Bishnoi (2001) studied the behaviour of daily and weekly return of five Indian stock market indices (Viz, Sensex, BSE-100, BSE-200, Nifty and NSE-500) during April 1996 to June 2001. Applying variance ratio test, they found mean reverting behaviour of Indian stock market indices and overreaction in unitary direction, which indicates the existence of arbitrage opportunities. Nath (2002) also observing mean reverting behavior in Nifty denied the existence of random walk in Indian stock market. Singh (2001) found that Indian commodity market is efficient especially when the time of maturity comes closer. He found Gur and Potato futures market, confirmed to efficient market hypothesis throughout. Whereas, he found efficiency in Castroseed, Hapur and Turmeric futures market, was sensitive to period for maturity. On the whole, since strong cointegration in spot market and the futures market was identified thus, Singh concluded that Indian commodity futures market was efficient. Wong et al., (2002) evaluated the efficiency of the Singapore Stock Exchange using daily close prices of Singapore STII for a period of 1974-1994. Applying Moving Average, Current-Trend Indicator and the Relative Strength Index, he observed that the stock price movements were predictable and the traders basing their decision on technical indicators can secure super normal profits. Marisetty (2003) also observed inefficiency in information dissemination in Indian stock market. He found that prices take 19 days to adjust to their intrinsic values. Further, he found that stock prices overreact to the information before adjusting to their intrinsic values. In brief, the efficient market hypothesis is simple in principle, but remains elusive. Evolving from an initially puzzling set of observations about the random character of security prices, it became the

dominant paradigm in finance during the 1970s. Dimson and Mussavian (1998) stated that during its heyday, a growing body of empirical research, supported the efficient market hypothesis by demonstrating the difficulty of beating the market, whether by analyzing publicly available information or by employing professional investment advisors. SECTION III: DATA BASE AND METHODOLOGY The current paper is an attempt to examine the weak form efficiency of Indian futures market. This section deals with database and methodology. 3.1 NEED OF THE STUDY The Indian capital market has been undergoing the phase of reformation since 1991. Introduction of Derivatives is an important episode in reform process. Risk hedging and price discovery are the pivot roles of the derivatives. This paper by investigating the efficiency of the Index equity futures market contributes to the current literature in following respects: 3.1.1. In an efficient market the returns are expected to confirm to normal distribution. Since the prior studies conducted in the Indian stock market observed day-ofthe-week-effect, it becomes apparent to examine the shape of returns in futures market. Examination of the shape of returns over the period gives evidence on the degree of speculation in the market. 3.1.2. Being a price discovery vehicle the futures are expected to reflect the prospective price movements in the underlying asset market. For this purpose the futures prices are expected to reflect all current information and the information regarding the prospective events, which are likely to happen in coming time. Investigating randomness in return behavior thus provides answer to this question. 3.2 DATABASE FOR CURRENT STUDY In India, as per the recommendations of L. C. Gupta Committee, equity futures trading was started in June 2000 by introducing Index futures on National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). However, trading on stock futures commenced on 9th Nov. 2001. Being the central stock exchange of the country, NSE witnesses maximum trade volume in F&O segment. Thus, one-month Index and stock futures, traded on NSE are considered in the current study. Daily closing values of Nifty futures are taken from 12th June 2000 till 31st July 2005. However, in the current study, only those stock futures have been considered, whose trading started on 9th Nov. 2001 and is continued till 31st July 2005 (see Appendix I). Price series data for Nifty futures as well as stock futures are obtained from website of NSE (www.nseindia.com). 3.3 METHODOLOGY The methodology deals with defining the manner of application of econometrical methods. In the current study, independence of return series is investigated for Nifty index and 24 stock futures. As returns are more likely to be normally distributed, the returns on Nifty index and individual stock futures are calculated in the following manner. Returns on Nifty futures: RNt = (Pnt Pnt-1) Pnt-1 Where: RNt = Returns on Nifty futures, in period t. Pnt = Price of nifty futures at day t. Pnt-1 = Price of nifty futures at day t-1. Returns on Stock futures: RSt = (Pnt Pnt-1) Pnt-1 Where: RSt = Returns on stock futures, in period t. PSt = Price of stock futures at day t. PSt-1 = Price of stock futures at day t-1.

3.3.1 Normality: The primary condition for the return series following random walk is that it confirms to normal distribution. To test whether futures returns confirms to the assumption of normal distribution or not, the Kolmogrov-Smirnov (K-S) goodness of fit test is employed. 3.3.2 Independence: To test whether the successive returns of Nifty or stock futures are independent or not, utocorrelation test and ARIMA process are employed. 3.3.2.A. Autocorrelation Test: Autocorrelation is a reliable measure for testing of independence of random variables in return series. The serial correlation coefficient measures the relationship between the values of a random variable at time t and its value in the previous period. Kendall (1953), Fama (1965), Stevenson and Bear (1970), Rendleman and Carabini (1979), Nordhaus (1987), Chen (1996), Reddy (1998), Mobarek & Keasey (2000) and Pant and Bishnoi (2002) applied autocorrelation test in various speculative markets over different periods. For a large sample, the Box-Ljung statistic follows the chisquare distribution with m degrees of freedom: LB = n(n+2) m k=1 (P^2k / n-k) ~2m Where, P^k =autocorrelation coefficient at lag k, and N = number of observations. 3.3.2.B. Autoregressive Integrated Moving Average (ARIMA): The Nifty and stock futures time series is found to be nonstationary at levels but by applying Augmented Dicky-Fuller test and Philips-Perron test, it is found that first difference Nifty and stock futures are stationary and they are found to be integrated of first order. Thus, in order to give robust interpretations on weak form of efficiency of Indian futures market, ARIMA model is applied. If we have to difference a time series d times to make it stationary and then apply the ARMA (p, q) model to it, we say that the original time series is ARIMA (p,d,q), where p denotes the number of autoregressive terms, d the number of time the series has to be differenced before it becomes stationary, and q the number of moving average terms (Gujarati, 2003). After observing Partial Autocorrelation Function (PACF) it was found that the serial correlation coefficient is significant at 1st lag, thus, ARIMA (1,1,1) model is applied, which means Autoregression of first order (AR1), first order difference of time series and Moving average of first order (MA1). Table 4.4 discusses ARIMA results. SECTION IV: RESULTS AND ANALYSIS This section deals with the results and analysis part. The descriptive statistics and KolmogrovSmirnov (K-S) goodness of fit test results are discussed in table 4.1. Table 4.2 and 4.3 deals with the autocorrelation results. Table 4.4 deals with ARIMA results. Descriptive statistics and the K-S goodness of fit test are good measures to investigate whether the return series confirms to normal distribution. For a time series confirming to normal distribution skewness and kurtosis should be equal to 0 and 3 respectively. From table 4.1 it is clear that Nifty futures return series do not confirm to normal distribution as skewness is different from 0 and kurtosis is significantly greater than 3. Moreover K-S (Z value) is significant at 5% significance level. Same evidence is found for stock futures. K-S (Z value) is significant for all stock futures (except for GRASIM, ITC, RELIANCE, SATYAMCOMP AND TATAMOTORS). In addition, the value of kurtosis is different from 3 (except for GRASIM and SATYAMCOMP) implying that futures daily return series do not confirm to normal

Table 4.1 Descriptive Statistics& Kolmogrov-Smirnov (Goodness of Fit Test Results): Futures on NIFTY ACC BAJAJAUTO BHEL BPCL CIPLA DRREDDY GRASIM GUJAMBCEM HDFC HINDALCO HINDLEVER HINDPETRO INFOSYSTCH ITC M&M MTNL RANBAXY RELIANCE SATYAMCOMP SBIN TATAPOWER TATATEA TATAMOTORS TISCO
*

N 1291 935 916 935 935 935 935 935 934 935 935 935 932 935 939 935 935 935 935 934 935 934 935 935 935

Mean 4.675E-04 1.369E-03 1.684E-03 2.581E-03 1.293E-03 3.916E-03 -3.86E-05 1.702E-03 4.579E-04 6.920E-04 9.048E-04 -1.08E-04 1.244E-03 7.000E-04 1.126E-03 2.590E-03 4.448E-04 1.547E-04 1.232E-03 1.748E-03 1.748E-03 1.511E-03 1.703E-03 2.106E-03 1.947E-03

Std. Deviation 1.494E-02 2.115E-02 1.870E-02 3.288E-02 3.238E-02 0.1540 2.124E-02 1.923E-02 3.487E-02 2.521E-02 1.876E-02 1.801E-02 2.885E-02 3.491E-02 1.638E-02 2.836E-02 3.043E-02 2.957E-02 1.919E-02 2.983E-02 2.290E-02 2.451E-02 2.111E-02 2.376E-02 2.662E-02

Skewness -1.326 (0.068) 0.093 (0.080) 0.350 (0.081) 0.183 (0.080) 0.885 (0.080) 26.485 (0.080) -0.580 (0.080) 0.252 (0.080) -16.677 (0.080) -8.038 (0.080) -0.173 (0.080) -0.552 (0.080) 0.370 (0.080) -10.809 (0.080) 0.294 (0.080) 0.815 (0.080) 1.003 (0.080) -7.911 (0.080) -0.236 (0.080) 0.367 (0.080) -0.061 (0.080) -0.670 (0.080) 0.183 (0.080) 0.169 (0.080) -2.760 (0.080)

Kurtosis 13.747 (0.136) 2.338 (0.160) 4.361 (0.161) 27.730 (0.160) 12.573 (0.160) 785.712 (0.160) 14.630 (0.160) 3.059 (0.160) 416.610 (0.160) 176.751 (0.160) 2.370 (0.160) 6.084 (0.160) 16.021 (0.160) 226.643 (0.160) 5.553 (0.159) 10.045 (0.160) 11.863 (0.160) 131.094 (0.160) 7.720 (0.160) 2.946 (0.160) 8.486 (0.160) 8.856 (0.160) 4.605 (0.160) 2.038 (0.160) 38.959 (0.160)

Positive 0.046 0.057 0.107 0.139 0.106 0.370 0.092 0.062 0.144 0.121 0.077 0.065 0.082 0.126 0.064 0.083 0.101 0.138 0.040 0.059 0.069 0.055 0.073 0.034 0.060

Absolute 0.074 0.069 0.107 0.143 0.106 0.370 0.095 0.063 0.173 0.131 0.087 0.065 0.082 0.147 0.064 0.083 0.101 0.163 0.040 0.059 0.072 0.065 0.073 0.039 0.073

Negative -0.074 -0.069 -0.083 -0.143 -0.096 -0.362 -0.095 -0.063 -0.173 -0.131 -0.087 -0.059 -0.078 -0.147 -0.051 -0.069 -0.093 -0.163 -0.040 -0.048 -0.072 -0.065 -0.066 -0.039 -0.073

K-S (Z Stat) 2.667* 2.105* 3.248* 4.365* 3.231* 11.325* 2.894* 1.937 5.279* 3.995* 2.657* 1.978* 2.499* 4.482* 1.953 2.535* 3.084* 4.976* 1.229 1.800 2.190* 1.997* 2.246* 1.181 2.226*

Significant at 5% significance level.

distribution. The evidence for rejection of normality in futures return series is consistent with those found by Kendall (1953), Fama (1965), Stevenson and Bear (1970), Chen (1996), Reddy (1997) and Kamath (1998) in the different speculative markets. Tests of serial correlation of equity futures returns in Table 4.2 and 4.3 reveal that Nifty futures returns are serially dependent at 4th lag whereas returns at 1st, 8th and 16th lag are close to zero implying no dependencies and LB coefficient is significant at higher lags, which implies that Nifty futures does not confirm to white noise. Serial correlation coefficient for 5 stock futures (i.e. GRASIM, HDFC, HINDALCO, HINDPETRO and TATATEA) is significant at 1st lag, whereas serial correlation coefficient at 4th lag is significant only for 4 stock futures (i.e. ACC, HINDALCO and TATATEA). Moreover at 8th lag only GRASIM and MTNL shows significant dependencies. However BPCL, GRASIM, ITC and TATAMOTORS have serial coefficient different from zero at 16th lag. The findings of LB test are interesting. The null hypothesis of LB test indicating randomness of return series movement is accepted for 13 stock futures (i.e. ACC, BAJAJAUTO, BPCL, DRREDDY, GUJAMBCEM, HINDLEVER, HINDPETRO, INFOSYSTCH, ITC, RANBAXY, RELIANCE, SBIN and TISCO). However LB stat for all other stock futures is rejected at 5% significance level implying trends in return movements. The findings of serial correlation and Box-Ljung statistic, shows mix results for weak form of efficiency in Indian futures market, but acceptance or rejection of random walk hypothesis in futures returns can t be inferred by just having a glimpse of serial correlation. Thus, in order to interpret the dependencies, further investigation is required. Randomness of futures return is further investigated by applying ARIMA.

Table 4.2 Summary results of Autocorrelation:

Coefficient No. of variables* violated zero serial correlation / white noise at 5% significance level 5 4 2 4 0 2 4 12 No. of variables* confirmed to zero serial correlation / white noise at 5% significance level 20 21 23 21 25 23 21 13 Total no. of variables*

Statistics Autocorrelation at Lag 1 4 8 16 Box-Ljung Statistics at Lag 1 4 8 16

25 25 25 25 25 25 25 25

* Variables include Nifty futures as well as stock futures.

10

Table 4.3 Autocorrelation Results:

Futures on N Coeff. LAG 1 S. E. 0.028 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 BoxLjung 0.908 0.274 1.769 0.925 1.719 0.061 0.306 8.920 0.048 6.579 11.428 1.330 5.443 1.048 0.194 0.006 4.187 1.908 0.024 0.381 0.637 4.507 9.585 0.858 1.167 Coeff 0.084* 0.097* -0.003 0.023 0.006 -0.013 0.049 0.067 0.020 -0.043 0.078* 0.012 -0.010 -0.003 0.054 0.008 -0.006 0.027 0.047 -0.038 0.031 0.054 0.076* 0.050 0.023 LAG 4 S. E. 0.028 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 BoxLjung 23.658 15.013 6.750 6.713 4.725 25.043 4.619 22.150 1.443 19.841 17.812 2.226 6.437 3.647 7.123 12.482 32.308* 5.175 6.284 4.332 3.218 21.919 28.694* 12.239 4.559 Coeff. -0.046 -0.013 -0.028 0.045 -0.027 0.020 -0.011 -0.081* 0.004 0.036 0.046 -0.030 -0.013 -0.009 -0.019 0.006 0.079* 0.017 0.028 0.030 0.003 -0.034 0.001 -0.001 0.045 LAG 8 S. E. 0.028 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.032 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 0.033 BoxLjung 31.683* 17.628 7.921 20.867 8.588 25.466 7.753 35.019* 2.213 24.843 20.693 3.257 6.988 5.201 8.423 15.226 40.141* 6.322 11.884 7.592 7.946 23.763 34.112* 18.145 12.338 Coeff. -0.020 -0.004 -0.016 -0.006 -0.099* -0.004 0.021 -0.076* -0.030 -0.014 -0.025 -0.023 -0.009 0.004 -0.074* -0.007 -0.050 -0.031 -0.018 -0.030 -0.014 0.040 -0.044 -0.074* -0.032 LAG 16 S. E. 0.028 0.032 0.033 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 0.032 BoxLjung 37.589* 25.626 12.353 47.907* 25.068 51.894* 12.207 44.971* 6.750 28.837* 30.877* 10.502 14.753 12.156 22.532 30.165* 55.759* 9.919 16.591 30.830* 19.574 38.433* 42.377* 39.136* 20.774

NIFTY 1291 0.026 ACC 935 -0.017 BAJAJAUTO 916 -0.044 BHEL 935 -0.031 BPCL 935 -0.043 CIPLA 935 -0.008 DRREDDY 935 0.018 GRASIM 935 0.098* GUJAMBCEM 934 -0.023 HDFC 935 -0.084* HINDALCO 935 0.110* HINDLEVER 935 0.038 HINDPETRO 932 0.076* INFOSYSTCH 935 0.033 ITC 939 -0.014 M&M 935 0.003 MTNL 935 0.067 RANBAXY 935 -0.045 RELIANCE 935 -0.005 SATYAMCOMP 934 -0.020 SBIN 935 -0.026 TATAPOWER 934 0.069 TATATEA 935 0.101* TATAMOTORS 935 0.030 TISCO 935 0.035 * Significant at 5% significance level.

11

ARIMA results as shown in table 4.4 are quite interesting. T ratio of AR1 and MA1 for Nifty futures returns is significant at 5% significance level, which implies that Nifty futures returns are predictable and do not follow random walk. In addition, T ratio of AR1 and MA1 for stock futures (except for seven stock futures viz, HDFC, HINDALCO, HINDLEVER, HINDPETRO, INFOSYSTCH, RANBAXY AND TISCO) is significant at 95% confidence level implying non-random movements in stock futures return movements. Although the T ratio of AR1 and MA1 is insignificant for seven stock futures but a close look on the PACF graph clarifies that there is no significant serial correlation in those seven stock futures. SECTION IV: SUMMARY OF RESULTS AND CONCLUSIONS The results in current study are very significant both for traders as well as for the regulators. As it was observed in different speculative markets, the Indian futures market returns also do not confirm to normal distribution. Moreover the value of kurtosis greater than 3 implies that the Indian futures market confirms to leptokurtic distribution which is sharply peaked having flattered tails, as compared to the normal distribution. Test of serial correlation based on Box-Ljung test statistics shows mix results for the efficiency of the futures market. LB coefficient is found to be significant for Nifty as well as 12 stock futures returns but the serial correlation coefficient is found insignificant after 1st lag for approximately all the stocks as well as for Nifty futures which indicates the possibility that the futures returns may be martingale (i.e. the predictable trends may not be profitable). Further in order to investigate the order of autoregression and seasonality of the futures market price series, mean and variance consistency is checked and the futures price series is found to be non-stationary but first difference returns are stationary. As the first difference Nifty and stock futures found to be stationary and the PACF signifies first order autoregression, thus, ARIMA (1,1,1) was found to be the best suited model for the Indian equity futures. With few exceptions, t ratio of AR1 and MA1 was found to be significant, which implies that returns are predictable. When the autocorrelation of those stocks was studied, whose t ratio was found to be insignificant, it was found that the serial correlation was significantly close to zero. These evidences may not be sufficient to characterize the Indian equity futures market as efficient in weak form. Lower transaction cost, high liquidity, huge trade volume, easy to arbitrage and take short position in futures market as compared to equity market, more flexibility and easy and flexible margin requirements are main characteristics of an efficient futures market. In Indian context, futures market returns are predictable (may not be profitable), which signifies that the Indian futures market is not informationally efficient. High volatility in the cash as well as futures market may be the reasons for inefficiency of Indian equity futures market. Moreover the derivative products are complex in nature, which could attract only a few traders, who have strong command in the cash market which itself leads to the concentration of trading volume around only a handful of traders which may hurt the cash market efficiency as well. High impact cost may be another factor which responsible for the non random movement of futures prices. Though the results as reported in this study states that Indian equity futures market is informationally inefficient but price discovery and causality testing between the two markets (i.e. futures and cash) will give correct results, whether the futures market is able to predict the cash market returns with accuracy? Traders are advised to use these results cautiously because neither the anomalies have been checked nor the degree of volatility in the futures market and its impact on underlying asset market is investigated. Moreover, since some results are contradictory, thus applying mechanical trading rule may give more reliable results for the help of traders. For regulators also these results are very much helpful. As observed in this paper, the futures returns are found to be non-random; the changes in the capital market can be infused through the futures. An efficient futures market enables the capital market regulators to easily control the volatility in the capital market through strict regulations in the futures market. Informational efficiency of the equity futures market has certain significant implications, viz; an informationally efficient equity futures market will lead to operational and allocation efficiency. Price discovery through equity futures market will certainly help the retail investors to hedge their risk exposure in the equity market. Since we all know that Indian investor is not well verse with the stock market variations and he don t know when to enter or quit the market. Informational efficiency of the equity

12

Table 4.4 Autoregression Integrated Moving Average Results (ARIMA) (1,1,1):

Coefficient Futures on N AR1a -0.664* 0.734* 0.971* 0.867* 0.424* 0.682* -0.963* -0.445* -0.978* 0.227 0.082 -0.129 0.153 -0.130 0.926* 0.614* -0.432* 0.104 -0.586* 0.787* -0.955* -0.532* -0.339* -0.952* -0.653 MA1b -0.731* 0.775* 0.968* 0.927* 0.516* 0.854* -0.970* -0.583* -0.973* 0.293 -0.027 -0.189 0.052 -0.157 0.932* 0.712* -0.553* 0.138 -0.636* 0.830* -0.952* -0.642* -0.468* -0.966* -0.682 CONc 0.652 0.304* 1.191* 0.874* 0.195 -0.801 -0.253 0.963* -0.104 0.243 0.684 -0.052 0.171 -0.703 1.094* 0.618* -0.003 -0.242 0.475* 0.390* 0.642* 0.288 0.564* 0.419 0.306 AR1a 0.161 0.236 0.160 0.055 0.257 0.058 0.086 0.158 0.161 0.453 0.301 0.531 0.317 1.145 0.253 0.150 0.184 0.954 0.329 0.165 0.346 0.168 0.203 0.061 0.464 MA1b 0.147 0.220 0.168 0.042 0.244 0.042 0.078 0.144 0.171 0.445 0.302 0.526 0.321 1.141 0.242 0.135 0.170 0.950 0.313 0.149 0.355 0.152 0.191 0.052 0.448 CONc 0.616 0.133 0.547 0.265 0.306 0.981 0.698 0.573 0.459 0.472 0.707 0.103 0.319 5.551 0.464 0.240 0.134 0.889 0.277 0.215 0.354 0.238 0.238 0.266 0.278 AR1a -4.123 3.105 6.061 15.756 1.654 11.689 -11.193 -2.812 -6.057 0.501 0.271 -0.243 0.483 -0.113 3.657 4.082 -2.345 0.109 -1.781 4.782 -2.761 -3.176 -1.669 -15.556 -1.407 MA1b -4.971 3.522 5.751 22.178 2.116 20.525 -12.467 -4.052 -5.694 0.658 -0.090 -0.359 0.162 -0.138 3.854 5.288 -3.257 0.145 -2.033 5.567 -2.684 -4.224 -2.447 -18.475 -1.525 CONc 1.057 2.284 2.177 3.303 0.636 -0.816 -0.362 1.681 -0.226 0.515 0.968 -0.509 0.535 -0.127 2.358 2.579 -0.026 -0.272 1.717 1.818 1.814 1.212 2.370 1.575 1.099 AR1a 0.000 0.002 0.000 0.000 0.098 0.000 0.000 0.005 0.000 0.617 0.786 0.808 0.629 0.910 0.000 0.000 0.019 0.913 0.075 0.000 0.006 0.002 0.095 0.000 0.160 MA1b 0.000 0.000 0.000 0.000 0.035 0.000 0.000 0.000 0.000 0.511 0.928 0.719 0.871 0.890 0.000 0.000 0.001 0.885 0.042 0.000 0.007 0.000 0.015 0.000 0.128 CONc 0.291 0.023 0.030 0.000 0.525 0.415 0.717 0.093 0.821 0.607 0.333 0.611 0.593 0.899 0.019 0.010 0.979 0.785 0.086 0.069 0.070 0.226 0.018 0.116 0.272 Standard Error T Ratio Probability

1291 NIFTY 935 ACC 916 BAJAJAUTO 935 BHEL 935 BPCL 935 CIPLA 935 DRREDDY 935 GRASIM 934 GUJAMBCEM 935 HDFC 935 HINDALCO 935 HINDLEVER 932 HINDPETRO 935 INFOSYSTCH 939 ITC 935 M&M 935 MTNL 935 RANBAXY 935 RELIANCE SATYAMCOMP 934 935 SBIN 934 TATAPOWER 935 TATATEA 935 TATAMOTORS 935 TISCO
a

* Significant at 5% significance level.

1st order Auto Regression, b 1st order Moving Average, c 1st order Constant.

13

futures market will be of great help to the investors in this sort. It will also make the role of SEBI more productive and active. SEBI can control the volatility in the equity market and the FII s position through equity futures market. An informationally efficient equity futures market will be of great help to the Indian institutional investors (viz; Mutual funds, Insurance companies, Development banks, Investment companies etc.) as well. As the interest of the small investors is involved in these institutions and these institutions actively participate in the equity market, informationally efficient equity futures will make the role of fund manager easier. As already stated that the informationally efficient equity futures will efficiently represents the prospective value of equity index as well as stock, it will certainly help the equity market to be informationally efficient and the anomalies in the equity market can be easily and speedily be detected and removed.

END NOTES: [1] William Peter Hamilton was the editor of Wall Street Journal, publishing forecasts based on Dow Theory. [2] Dow Jones is the main theory of technicians. [3] Fama also from time to time presented significant evidences, to support the results of Cowels (1933). In 1965, 1966, 1970, and 1991 through his publication, he stated that if patterns were true then the professional analyst would have edge to secure super normal profits. But since the serial correlation evidenced the absence of lagged response in price movements, he again and again refuted the productive use of technical theories. He referred the activity of interpreting the past price movements as a non-productive time pass.

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Appendix I

Futures on Index / Individual Securities S&P CNX Nifty Associated Cement Co. Ltd. Bajaj Auto Ltd. Bharat Heavy Electricals Ltd. Bharat Petroleum Corporation Ltd. Cipla Ltd. Dr. Reddy's Laboratories Ltd. Grasim Industries Ltd. Gujarat Ambuja Cement Ltd. Housing Development Finance Corporation Ltd. Hindalco Industries Ltd. Hindustan Lever Ltd. Hindustan Petroleum Corporation Ltd. Infosys Technologies Ltd. ITC Ltd. Mahindra & Mahindra Ltd. Mahanagar Telephone Nigam Ltd. Ranbaxy Laboratories Ltd. Reliance Industries Ltd. Satyam Computer Services Ltd. State Bank of India Tata Power Co. Ltd. Tata Tea Ltd. Tata Motors Ltd. Tata Iron and Steel Co. Ltd. NIFTY ACC

Symbol

BAJAJAUTO BHEL BPCL CIPLA DRREDDY GRASIM GUJAMBCEM HDFC HINDALCO HINDLEVER HINDPETRO INFOSYSTCH ITC M&M MTNL RANBAXY RELIANCE SATYAMCOMP SBIN TATAPOWER TATATEA TATAMOTORS* TISCO

* The earlier symbol of TATAMOTORS was TELCO.

17

PROFILE OF AUTHORS
1. Kapil Gupta, did M. Com. From Guru Nanak Dev University, Amritsar in 2002. Currently he is working as Junior Research Fellow in Commerce and Business Management Department, Guru Nanak Dev University, Amritsar. Dr. Balwinder Singh earned his Ph.D from Kurukshetra University, Kurukshetra. Currently he is working as Reader in Commerce and Business Management Department, Guru Nanak Dev University, Amritsar.

2.

18