Market Efficiency Analysis

MAIN PURPOSE
The purpose of this part of the assignment is to make candidates/students familiar with some statistical techniques used in

examining efficiency in financial markets and/or financial instruments. You are required to make proper use of both financial

theory and empirical practice using spreadsheets and statistical tools, such as MS Excel, EViews and SPSS.

SCENARIO
You are employed as a junior analyst of a newly established Tracker Fund called Superior Index Fund Ltd (SIF). The company is

currently located in the City of London and their core activity is the management of tracker/index portfolios (from the

theory we”ve seen so far, you should be familiar with these terms).
Having established a good clientele in the UK and a very successful portfolio for London Stock Exchange (LSE), your firm is

considering expanding abroad. Your manager, Mr. James Broderick has asked you to examine the efficiency of an overseas market

in Snowbodia, a country located in Eastern Europe. Although the market has been established for at least 15 years now, it has

never been subject to rigorous examination. Another manager, Ms. Isabella Ostrowska, has worked in Snowbodia 10 years ago and

based on her work experience then, thinks Snowbodia”s stock market is not efficient.
Depending on your findings and recommendations, your company is prepared to establish a new tracker fund that will cover the

entire universe of stocks in this new country. This fund will be marketed to wealthy individual investors from the UK.

BE WARNED this is a potential investment that can generate millions of pounds for your company and therefore mistakes are

NOT TOLERATED at this point.
James Broderick has given you the data for analysis. This includes a randomly selected sample of adjusted price-series from

the entire universe of stocks listed in Snowbodia.

REQUIREMENTS
As an analyst, you are required to do the following:

(a) Examine the normality of the stocks” return-series (using the Bera-Jarque test in EViews and Kolmogorov-Smirnov test in

SPSS);
(b) Perform a Run Test (in SPSS) to identify possible irregularities in the price series.
(c) Discuss the importance of specification tests (such as RESET) for your analysis.
(d) Do the ADF/PP/KPSS tests in EViews. Then, test the H0: proportion of inefficient stocks is not statistically different

from zero.
(e) Choose any 10 stocks and fit an ARMA(p,q) model and comment on the choice of p and q. Discuss the importance of

information criteria on choosing the appropriate number of lags. What is the purpose of the Ljung-Box test when fitting ARMA

models?
(f) Describe how you would use the theory of exponential smoothing to try and forecast share prices.
(g) Write a short report with your findings.

WRITTEN REPORT
The written report should be around 4,000 words in length, word-processed. You should also attach all relevant tables with

summaries of results as an appendix to your report. In the report you should:
• Explain the rationale behind your empirical tests and the methodology adopted. This part has to be concise and precise. No

marks will be given for clutter as in a real life scenarioit will lead to a P45!
• You have to use the appropriate scientific rhetoric. Therefore, you should define clearly your null and alternative

hypotheses tested in each stage of the analysis.
• Provide a clear definition of the techniques/statistical tests used and WHY?
• Be precise in the underlying theory of efficient markets as all statistical numbers are as good as the story behind them!

(We”ve covered these aspects in lecture five when we”ve examined the philosophical aspect of scientific research in Finance).

ASSESSMENT AND MARKING SCHEME
The majority of the marks will be given to students that produce evidence of:
• Good understanding of the theory of efficient markets.
• Good understanding of statistical procedures.
• Ability to link properly the first two points above
• Critical thinking in the interpretation of the findings. (Don”t forget, this can be easily a real case scenario that could

cost a lot of people a lot of serious money running to some hundreds of £millions)

When you are looking at your report, some good questions to ask are:

Does this report show that I could hold an intelligible and well-informed discussion on the stock market with a market

professional, like a stock-broker or an academic in the field? orWhy should I choose this statistical technique instead of

the other one?, orOK. I”ve got my number, so WHAT now? What these numbers tell me about the market?

The grade you achieve for this part will depend entirely on the level of understanding demonstrated in your report and your

sound empirical backing.

In terms of referencing, you are required to use the Harvard system of citation. Also, beware of the academic regulations

regarding plagiarism. Your report should also include a CD with your results from all statistical tests and the report

itself.

HINTS
I strongly recommend that you get a copy of the SPSS and EViews manuals as soon as you have received your assignment briefso

as to familiarise yourself with elementary statistics and hypothesis testing procedures.
Use your lecture notes to grasp the theory behind efficient markets and basic financial econometrics.
Think about potential problems of financial time series such as those of heteroscedasticity and autocorrelation. Is there any

possibility of these errors affecting your analysis?

ADDITIONAL SUGGESTED READINGS
Brooks, C. (2008) Introductory Econometrics for Finance, 2nd Edition (2011). Cambridge University Press.
Field A. (2005) Discovering Statistics Using SPSS. Sage Publications. London, UK.
Gujarati, D. (1995) Basic Econometrics. 3rd Edition. McGraw-Hill.
Maddala, G.S. (2001) Introduction to Econometrics. 3rd Edition. John Wiley &
Sons.

THE ASSIGNMENT STRUCTURE
1- EXCTSUMMERY
2-INTODUCTION
3-MAIN BODY
4-CONCLUSION
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