Market Efficiency and International Diversification : Evidence from India

This study evaluates one of the most important emerging markets, India, for its efficiency and for its potential to offer diversification benefits to international investors. Two of the markets in India are analyzed (Bombay Stock Exchange (BSE) and Indian National Exchange (INE)) for their relationships with the international equity markets based on end-of-day data for individual stocks (35,003 stocks for international markets and 1,522 stocks for Indian markets). Market independence and efficiency is evaluated through evaluation of market as well as individual stock returns. Market-wide tests include; 1) contemporaneous relationship, 2) Granger type causality and 3) day-of-the-week effect. As an evidence of international integration, contemporaneous relationship is strong. Causal relationship is also evident with some of the regional markets as well as with influential international markets. Day-of-the-week effect seems to be a spillover from international markets. Tests on individual Indian stocks include: 1) panel estimation of Granger causality, 2) one-by-one estimation of Granger causality and 3) runs test. 86% of BSE and 91% of INE are Granger caused by at least one international market even after controlling for their liquidity and market returns. Finally, at 5% statistical significance, for runs of 3 (4), about 40% (35%) of the stocks traded on BSE do not change randomly. This level is significantly lower, 19% (16%), for INE with runs of 3 (4). In sum, Indian markets are well integrated with the international equity markets, a characteristic that lowers the international diversification benefits. While day-of-the-week effect is an international spillover, it may be possible to predict individual Indian stocks' returns through causality with international equity markets and through momentum trading techniques