A Research Report on

Efficient Market Hypothesis: Empirical Evidence from Pakistan

Submitted by

ASAD TARIQ 1425164

ABDUL MUNIM KHAN 1425132

DANISH KHALID 1435318

Advisor

SHEIKH KHURRAM

Date 12/11/2015
 Abstract

This paper endeavors to examine efficiency in the Karachi Stock Exchange 100 (KSE
100 index) under the theory of Efficient Market Hypothesis (EMH). In particular the
paper aim to examine whether stock market of Pakistan i.e. KSE is information
efficient or not to help all the investors of this market. In order to find efficiency of the
market we applied the unit root variance analysis along with the time series analysis
for the years 2010 to 2014. The collection of data was done based on weekly end
points for the five years. Augmented Dickey-Fuller statistics was applied using the E-
Views so that to analyze the unit root variance of data. The results obtained by
augmented-ducker fully test showed that data of KSE 100 index from 2010-2014 have
unit root, consequently showing market is non-stationary and therefore exist a sense
of randomness among stock prices of KSE 100 index or it does follow a random walk
and the market is weak form efficient in all years individually as well as collectively.
Moreover, the time series analysis showed a trend in the market performance, so it
can also be concluded that the market prices of securities and shares can be
determined based on the historical data. When the market was tested individually, the
results of ADF showed that market is weak form efficient, as there existed the unit
root in each year. However, individual analysis showed that there was no trend in the
index movement. On the other side, the time series analysis showed a bullish trend in
overall performance of the market for the observed time period. As market broke
many psychological barriers and index touched new peaks by the end of this time
period.

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 ACKNOWLEDGEMENT

Praise for Almighty Allah, the most beneficent and most merciful who gave us
strength and courage to compile our Research Project on “Efficient Market
Hypothesis: Empirical Evidence from Pakistan”. This research paper is made possible
through the help and support from everyone, including: teachers, friends, Investors
and in essence, all sentient beings.

We would first and foremost like to thank our Research Project advisor Mr. Khurram
Sheikh who gave us the opportunity to conduct this Project and without whom we
wouldn’t have been able to compile and cluster the process of data and information
that we gathered. He was indeed very helpful throughout our research from start till
the end in guiding and advising us very patiently.
We would also like to Acknowledge SZABIST for providing us the opportunity to
utilize our skills and apply immense knowledge that this respective institute provided
us in the last 1.5 years of learning in our Management Business Administrative
Program to test.

iii
Declaration

We certify that this is our own original research work. The work has not, in whole or
in part, been presented elsewhere for assessment. Where material has been used from
other sources, it has been properly acknowledged. If this statement is untrue and if I
am found guilty of the plagiarism, the punitive actions against me may be taken as per
the SZABIST Anti Plagiarism Policy.

Signatures: _____________________________ Date: __________________

Name of the student: Registration No:

Abdul Munim Khan 1425132

Asad Tariq 1425164

Danish Khalid 1435318

Degree: MBA

Program: Management Science

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Certificate of Approval

This is to certify that Abdul Munim Khan, Asad Tariq, and Danish Khalid bearing
registration no(s) 1425132, 1425164 and 1435318 has completed their Research
Project, entitled Efficient Market Hypothesis: Empirical Evidence from Pakistan in
partial fulfillment of the requirements for the completion of Research Project under
the supervision of Sheikh Khurram Fazal. The research project meets the prescribed
requirements and standard as set by Management Science Department, Shaheed
Zulfiqar Ali Bhutto Institute of Science & Technology (SZABIST), Karachi, Pakistan.

_______________________
Research Advisor
Sheikh Khurram Fazal

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Table of Contents
1.0 Introduction: ............................................................................................................. 1

1.1 Problem Statement: ......................................................................................... 5

1.2 Scope: ................................................................................................................... 5

1.3 Research Objectives: ............................................................................................ 6

1.4 Research Hypothesis: ........................................................................................... 6

1.5 Limitations: .......................................................................................................... 6

1.6 Definitions: .......................................................................................................... 6

2.0 Literature Review: ................................................................................................... 7

2.1 Efficient Market Hypothesis: ............................................................................... 7

2.2 Critics against EMH:............................................................................................ 9

2.3 EMH and World Markets..................................................................................... 9

2.4 EMH and Pakistani Markets: ............................................................................. 11

3.0 Research Methodology .......................................................................................... 12

3.1 Theoretical Framework: ..................................................................................... 12

3.2 Conceptual Framework: ..................................................................................... 13

3.3 Data Collection and Tests .................................................................................. 13

4.0 Findings and Analysis:........................................................................................... 14

4.1 Time-series analysis: .......................................................................................... 14

4.2 Unit-root Analysis:............................................................................................. 18

5.0 Discussion and Conclusion: ................................................................................... 23

References .................................................................................................................... 27

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1.0 Introduction:
Pakistan economic growth is showing signs of sustained recovery that started in 2013-
14 and has accelerated in 2014-2015. Pakistan’s macroeconomic variables continued
to display improvement in Fiscal Year 2015 as economic growth, inflation, fiscal
deficit and external account showed improvement over the previous years. At the
same time, the government and law enforcement agencies efforts in improving law
and order situation has also brought in investors confidence in both domestic and
foreign markets. Especially from the foreign investors perspective, developing
economies like Pakistan are of interest to increase their financial wealth, which can be
witnessed through increasing inflows in portfolio investment in Pakistani financial
markets.

It is important to observe that not only the macroeconomic factors like GDP, inflation,
interest rate, money supply and exchange rate affect the stock market index but also
the global factors as well as the microeconomic factors may affect the market
performance. Global factors may include change in global interest rate, trade
liberalization, gold prices, oil prices fluctuation in USD value, and so forth (Siddiqui,
2014).

The recent fall in international oil price has resulted in lower inflation, which has
given space for the central bank to promote economic growth by reducing key interest
rates, and also it has improved the trade outlook for Pakistan (Siddiqui, 2014). This is
because Inflation hit the lowest level at 1.72 percent in August 2015 that is the lowest
since 2003. The key interest rate went down to 6 percent level as announced in the
monetary policy of 12 September 2015, which is historically the lowest (Edition,
2015). Improved external account and contained current account deficit and capital
market created history in 2014 when KSE 100 index gained 6,870 points generating
sufficient return of 27% through foreign investment in free float market and
Governments’ mega public offering of IPO sales of shares as well as declining Pak
rupee-dollar trend which bagged a ranking of being third amongst the top ten best

1
performing markets in 2014 (Agencies, 2015) hence improve improved outlook have
set bullish trend.
However, the political factors and catastrophes have affected the stock markets in a
volatile manner. In the last fifteen years many political and catastrophic incidents
happened in Pakistan. Pakistan experienced both dictatorship and democracy in this
period. Many key political and public figures got assassinated. Pakistan also
experienced volatility due to war on terror. Also there have been extreme catastrophes
and natural calamities like earthquakes and floods. Because of these uncertain
situations investors are doubtful about the market (Taimur & Khan, 2015).
Financial Markets mainly refer to any marketplace where buyers and sellers
participate in trade of assets such as bond, equities derivatives and currency. These
assets if are accumulated for long-term than can be classified as capital assets. In
financial capital generation, there are two broad sources from where an individual or
an entity can raise capital funds, i.e. through either debt markets, which is the most
common method where a borrower borrows money from another party(ies) known as
lender(s) on which the borrower not only pays back the principal amount but also the
interest on it, or through equity markets, where an individual places its personal funds
into the business or an entity generally raises capital by offering its shares to other
investors as their own investor partners. Generally, a company uses both of these
sources to arrange long-term fund requirements, whose mix may vary depending upon
the industry, business needs and opportunities at hand (Sachs & Warner, 1997).
In equity capital market, two market branches can be further classified, which are
“primary market” and “secondary market”. In primary market, shares and other
similar financial instruments are sold to general buyers by the company through initial
public offering (IPO), which may not be offered in one shot but can also be offered in
parts to general public and/ or high net worth buyers. This offering of financial
instruments is done based on SECP’s regulatory requirements, through atleast two or
more financial intermediaries, including commercial banks and investment banks who
are required to arrange under-writing as well. In secondary market, the trading of the
financial instruments is done by investors, who subscribed the offering in primary
market. In secondary market, key players are the dealers or brokers, who provide the

2
platform to buyers and sellers to actually trade these instruments as well as to
determine the prices for these assets.
Stock markets are considered as one of the strong indicators of any economy, as
development and growth of an economy is generally influenced and reflected by
capital market movements. Moreover, if the capital market is efficient enough than it
can provide opportunity to both domestic and foreign investors to increase their
returns and wealth (Nisar & FCMA, 2012).
Pakistan’s stock market is a well-recognized second oldest market in South Asia. It
has currently three exchanges which namely, Karachi Stock Exchange (KSE), Lahore
Stock Exchange (LSE) and Islamabad Stock Exchange (ISE). Among these Karachi
stock exchanges is the most well-known, old and active. It was established on
September 1947 and is the most liquid stock exchange in Pakistan. KSE is regulated
by SECP to protect investors’ interest for safe and fair dealing with efficiency in the
market by its rules and regulations ( KSE Annual Report, 2011).

Karachi Stock Exchange comprises of four indices such as KSE 100, KSE 30, KMI
30 and KSE all share indices. Among these indices, KSE 100 Index is the most
represented index of Pakistan stock market. This is because it shows major firms
performance collectively which consist of 100 stocks based on weighted market
capitalization. All top capitalized firms of each sector of the 34 sectors are taken first
and then the remaining 66 stocks are taken based on weighted market capitalization
regardless of the sector (Shehryar & Javid, 2014). For this purpose, this research is
aimed at selecting the KSE 100 index variable, which is considered to be inclusive of
most of the blue chip scripts.

As the purpose is to find out factors that affect the stock return, macroeconomic
variables are quite essential to determine the expected fluctuations in the stock market
index.

Three stock exchanges Karachi Stock Exchange (KSE), Lahore Stock Exchange
(LSE) and Islamabad Stock Exchange (ISE) of the nation will shortly be converted
into one national stock exchange. The general agreement is to achieve the
government’s vision of a fair, efficient and transparent market with one national stock

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exchange conforming to international level. The actual reason behind merging of the
stock exchanges is to finish the process of demutualization (Raza, 2015).

Demutualization has its flaws. Through such process it has created conflict of interest
between market participants and operator of exchange, difference of opinion between
SECP and KSE when comes to ensure transparency and finally, rules and regulations
differ across country to country and cannot be uniformed (KSE demutualization,
2008).

The Demutualization Act of 2012 has restrictions that only foreign buyer can
purchase the 40 percent management share of the stock exchanges which delayed the
demutualization process for about three years. Recently, a Turkish company has
shown interest of buying the KSE shares. The Turkish delegation has reached
Pakistan to complete the purchase of 40 per cent shares of the KSE worth around Rs4-
5 billion which may further open doors for Pakistan stock market (Abduhu, 2015).

Efficient Market:
An American economist Eugene Fama introduced the term Efficient Market in early
60’s and defined this term as the market that rapidly tune itself to new information
(Haque, Chun Liu, & Nisa, 2011). There is broad amount of literature on market
efficiency to cope up with financing and investing in stock markets. The idea of
efficiency in stock market helps to understand capital market and taking right decision
for investment (Haroon, 2012)
Efficient Market hypothesis or EMH is the phenomenon that states that it is
impossible to beat the market due to changing environmental circumstances. Shares
or stocks are transacted in secondary markets. According to the phenomenon the
market generally tends to derive stock prices based on the information available on
the script, its future growth and payout perspective as well as the environment
prevailing within the financial markets and economy itself. Theses markets do have
some time lag on the availability and passage of information to stock prices which
makes stocks, as there are mainly three types of efficient market hypothesis (EMH):

1. Weak Form Efficiency: Information based on historical data and investor can
not earn high profit

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 2. Semi Strong Form Efficiency: Market information is based on currently
disclosed public information which is absorbed immediately in the market

3. Strong Form Efficiency: All information known to any market participant

(private information) (Sultan, Madah, & Khalid, 2013)

In this research is aiming at applying the concepts of EMH over Pakistani market to
understand whether this phenomenon has a strong relation with the Pakistan’s stock
market or a weak one or it simply doesn’t holds true.

For the purpose of research, there would be an attempt to apply a time series analysis
over the KSE 100 index. The type of data that would be used in this research would
mostly be the secondary data and would be using the statistical and econometric tools
to analyze the data and interpret the estimates.

1.1 Problem Statement:

There has been an increasing trend in the investment in the stock markets and there
has also been an increase in the number of the listed companies in the stock exchange.
The problem that intrigued to conduct this research study is the price fluctuations in
the stocks trade, as if the prices are changing anonymously or is there any role of
market information in this rise or fall of the prices or they follow a general trend.
Observing most of the matters, it is intended to analyze that if the market has been
true representative of the market information or not.

1.2 Scope:
The research is aimed to identify the form of the EMH that exists in the Pakistan’s
stock market by applying quantitative analysis using econometric and statistical tools
over the collected data for which the KSE 100 Index data would be analyzed for the
considered time span. The results of the study would help the policy makers,
investors, investment fund and its efficiency or capability to in culprit information in
stock price in understanding the movements in the stock market of Pakistan.
Moreover, this study would also enable the academia in understanding the application
of EMH in Pakistani market.

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1.3 Research Objectives:
 To explain the phenomenon of EMH and its different forms with support of
theoretical empirical literature
 To identify whether the concepts of EMH are applicable over the Pakistan’s
stock market.

1.4 Research Hypothesis:

 KSE 100 Index is information inefficient.

1.5 Limitations:
In this study the aim is to analyze the efficiency of the stock exchange working in the
Pakistan. However, this research has been restricted to consider the KSE 100 index
only, instead of analyzing the whole market or even individual stocks. Moreover, the
time frame selected is of last five years, which short-term view of market.

1.6 Definitions:
Demutualization: When a mutual company owned by its members transforms into a
company owned by shareholders (Aggarwal, 2002).

Equity Markets: where an entity generally raises capital by offering its shares to
other investors as their own investor partners (Bekaert & Harvey, 1997)

Efficient Market hypothesis (EMH): states that it is impossible to beat the market
due to changing environmental circumstances (Malkiel, 2003)

Semi Strong Form Efficiency: Market information is based on currently disclosed

public information that is absorbed immediately in the market (Malkiel, 2003).

Strong Form Efficiency: All information known to any market participant (Malkiel,
2003).

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Trade liberalization: refers to the removal or reduction of barriers on the free
exchange of goods between nations (KSE demutualization, 2008).

Weak Form Efficiency: Information based on historical data and investor can not
earn high profit (Malkiel, 2003).

Underwriting: means to sign and accept liability and promising payment in case loss
occurs (Sachs & Warner, 1997).

2.0 Literature Review:

2.1 Efficient Market Hypothesis:

The phenomenon of efficient market hypothesis applies to test the stock markets, so
that to test their performance. Several studies have been concluded on various stock
markets around the world, showing the various forms of efficiency in different
markets. The efficiency of the markets is categorized in three forms such as weak
(inefficient), semi strong and strong (Sultan, Madah, & Khalid, 2013).

According to the studies, emerging markets commonly show inefficiency however,

the developed markets mostly reflect the other two forms of efficiency. Inefficient or
weak form of efficiency commonly suggests that the market is inefficient in reflecting
the available relevant information in the prices of stocks and securities, while the
efficiency of market says that the market is able to reflect the available relevant
information onto the prices of stocks and securities (Timmerman & Granger, 2004).

In simple words, inefficiency of markets is the representation of state where the prices
of stocks/securities are dependent on each other and the investor is not able to get
enough out of the investments (Rejichi & Aloui, 2012). Since, last few years the focus
of investors has shifted towards the emerging markets as there has been a significant
increase in the number of opportunities along with expectations of higher returns and
a significant decrease in the equity barriers, the efficiency of emerging markets is of
greater importance (Poshakwale, 1996).

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Since the phenomenon of EMH states that efficiency of market depends on its ability
to reflect all the available relevant information in the stock prices, it strongly argues
another widely discussed phenomenon of random walk (Gandhi, Bulsara, & Patel,
2011). However, the random walk model is complete opposite of the EMH, as it states
that the changes in prices could be predicted from the previous data about price or
return and it neglects all the available related information, due to which a normal
investor is able to get as much as return as an expert could get (Gandhi, Bulsara, &
Patel, 2011).

When the market is highly dependent upon the historical data and information (prices
and returns), the market shows a weak form of efficiency. In such situation, an
investor is unable to earn exceptional profits from the market as his trades are based
upon the past trends in return and prices. Moreover, when the market shows weak
form of efficiency, return on stocks become unpredictable and there remains no
pattern for asset pricing, resulting in non-application of the technical analysis for the
estimation of profits. Eventually, all the future pricing decisions and trades become
dependent upon the information other than the price series which leads towards the
random walk (Gupta & Basu, 2007).

When the market is able to reflect all the publicly available information in the prices
of stocks and securities, there exists a semi strong form of efficiency in the market.
Those investors who make their trading decision based on the publicly available
information are unable to earn above average return from their portfolios (Gandhi,
Bulsara, & Patel, 2011). This shows that the market is highly sensitive to all relevant
publicly available information and the trading backed by such information cannot
produce excess profits for the investors. This form of efficiency shows that neither
technical analysis nor fundamental analysis help the investor in earning exceptional
results (Gupta & Basu, 2007).

When the market is able to reflect all relevant available information, including the
company secrets, in the prices of stocks and securities there exist a strong form of
efficiency. In such form of efficiency the trades based on the information available
cannot generate excess profits. This form of efficiency strongly supports the technical

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analysis, as both of these state that the stock markets are always able to reflect all the
available information in the prices of stocks (Gupta & Basu, 2007).

2.2 Critics against EMH:

Many researchers have argues against the concepts of EMH as they believe that since
the markets exist there would remain a difference in opinion of the investors and
some investors would be more rational and some would be less rational while making
there trading decisions. These rational and irrational behaviors there might exist some
irregularities in the pricing of assets as well as there could be some patterns in the
returns, mostly for short terms (Lund, 2015).

Grossman and Stiglitz (1980) argued that if the markets become completely efficient
then there would exist no charm for professionals and companies to uncover the
relevant information that would get reflected on the share prices instantaneously.
Moreover, they argued that it is not possible that all the information gets so quickly
available for the public. According to their research mostly experts have access to
data sources, which they use to get the better returns from their portfolios (Grossman
& Stiglitz, 1980).

However, despite all critics, such periods in the history have been observed that
showed the complete reflection of market information, such as in the year 1999 where
there was complete utilization of market information. Moreover, in such situations,
the decision based on the available information or history records have seen not to
produce excess profits for the investors (Malkiel, 2003).

2.3 EMH and World Markets

In the research conducted by Ojah and Karemera (1999), auto regressive moving
averages and variance ratio tests were applied over the United States dollar based
national equities for the time between 1987 to 1997. Variance ratio test was applied so
that to analyze the random walk of the prices. The results of the study concluded that
the markets of Brazil, Chile, Argentina and Mexico followed a random walk in their
pricing procedures while except Chile all of the mentioned market showed a weak
form of efficiency. This conclusion implied that for those investors who want to

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invest in these emerging markets the decision based on historical data could generate
average returns for them, moreover, the market returns were independent from the
past returns (Ojah & Karemera, 1999).

While on the other hand a research carried out to analyze the efficiency in more
developed markets i.e. New York Stock Exchange and Zagreb Stock Exchange, for
the time frame of thirteen year from 1997 to 2010, the results were different. In the
time period selected for the research purpose 2008-2009 was a period of crisis. To test
the efficiency, correlation test was applied and the results of the test showed that these
developed showed the efficient form of EMH, except for the period of crisis where
ZSE were slightly inefficient (Sonje, Alajbeg , & Babus , 2011).

Investing the performance of 44 Morgan Stanely International indices based on their

52 weeks high price strategy, for the period ranging from 1970-2009, incorporated
descriptive and momentum strategy, another research concluded a mixed result. The
research focused upon both the developed and emerging markets. The conclusion of
the study was that the momentum strategy might be a more beneficial way to generate
better profits than that of the 52 weeks high price strategy. Thus, concluding that most
of the time markets are efficient and are able to reflect all the relevant available
information in the prices of stocks (Bornholt & Malin , 2011).

In the research carried over the daily closing values of the NASDAQ, Dow jones and
S&P 500 index for the period of 1971-2009, various unit root tests were applied over
the data to analyze the efficiency of the markets. The results of the study concluded
that all three of the markets were not stationery and were not predictable, hence, these
markets showed a semi strong and strong form of efficiency in their operations
(Murthy, Washer, & Wingender , 2011).

Olowe (1999), in his study over the Nigerian markets wanted to discover that if the
price of stocks in this market is adjustable to historical data or not. In order to analyze
efficiency of this market the correlation analysis was applied over the monthly data
collected for the period of 1981-1992, along with some technical trading tools (used
as a statistical measure for decision-making process). The results of the study

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concluded that the prices of stocks were a function of the historical data, showing the
Nigerian stock exchange as the weak form efficient (Olowe, 1999).

In another research, the weak form of efficiency for Financial Times Stock Exchange
is under observation. Using the unit root tests they have concluded which states that
the market is non-stationery and therefor the random market hypothesis is more
interpretive. According to the observations the weak for of efficiency is existent in the
market (Gandhi, Bulsara, & Patel, 2011).

In another research paper researchers have examined the weak form of efficient
market hypothesis on the four major stock exchanges of South Asia including, India,
Pakistan, Bangladesh and Sri Lanka. Historical index values on a monthly, weekly
and daily basis for a period of 14 Years (1997-2011) were used for analysis. They
applied four statistical tests such as runs test, serial correlation, unit root and variance
ratio test. None of the four major stock markets of south-Asia follows Random walk
and hence all these markets are not the weak form of efficient market (Nisar &
FCMA, 2012).

Borges, in her study, examined the weak form of efficient market hypothesis on to
stock market indexes of France, Germany, UK, Greece, Portugal and Spain. The tests
are performed using daily and monthly data for the whole period and for the period of
the last five years, i.e., 2003 to 2007. They used a serial correlation test, a runs test, an
augmented Dickey-Fuller test and the multiple variance ratio tests. Monthly prices
and returns follow random walks in all six countries Invalid source specified..

2.4 EMH and Pakistani Markets:

Tahir in year 2011, focusing upon the analysis of the EMH, tested its concepts in
Pakistan as if what form of EMH is existing Pakistan. For the purpose, she has used
various theoretical concepts such as unit tests, runs test and ARIMA. The data used in
this research is the secondary data, which represent the price index of 20 listed
companies in KSE for 9 years. The results of the study shows that the concepts of

11
EMH could be applied in the Pakistani markets and price index could be one of the
factors to evaluate the future investment decisions (Tahir , 2011).

Haque, Liu and Nisa (2011), tested out the weak form efficiency of Pakistani stock
market by examining the weekly KSE 100 index over the period 2000-2010. They
have also applied the run tests and variance tests over the data collected from KSE
websites. The results generated from the tests showed that the Pakistani market is not
a weak form of efficient markets (Haque, Chun Liu, & Nisa, 2011).

This research conducted by Andrew Worthington and Helen Higgs in 2005, analyzed
and focused 10 Developing Countries including Pakistan and five Developed
Countries are tested on their “Weak-Form Efficiency”. Various tests were performed
such as Random Walk Hypothesis, Serial Dependence Test, Unit Roots Test and
Multiple Variance Ratio Test which resulted in that both Developing and Developed
Countries are Weak-Form Inefficient except for Developed countries by satisfying the
Random Walk Theory or not (Worthington & Higgs, 2005).

3.0 Research Methodology

3.1 Theoretical Framework:
In order to determine the efficiency, is to test that whether the variables have an effect
on the “Random-Walk” of the Stock Market or not. The variables that affect the stock
market can be; market information, market structure and other economic factors
(Haroon, 2012). Market Information entails those elements that have impact on the
organizations, which are already listed in the companies’ effectiveness. Market
structure effectively restructures the appropriate pricing of the capital that impacts the
intrinsic value of company. Other economic Factors are such as government policy
that has effect on the level of FDI visiting the country.

Since the basic aim of the study is to highlight that whether the Karachi stock
exchange is information efficient or not, in this research, we have adapted the
research method concluded by Nisar and Hanif (2012). They applied the unit root
tests over the data of south Asian markets for the years ranging from 1997 to 2011.

12
They collected the weekly, monthly and annual index points of the relevant stock
markets and applied the unit root test over the data to accumulate the week form of
efficiency and random walk of the markets. The interpretations for the study were
based upon the result of unit root as if the unit root existed in the data it was
considered information inefficient or weak form efficient and if otherwise market was
to be considered as strong form efficient.

3.2 Conceptual Framework:

However, we have adopted the research model carried out by the Nisar and Hanif
(2012) we have made some changes to the model, as it seemed to be having some
issues. Nisar and Hanif (2012) applied the unit root test over the data to accumulate
the efficiency of the market while neglecting the growth rate between the varying
index points. Therefore, in order to cope up with the growth rate situation we applied
the natural log over the data and then applied the unit root to check the efficiency of
market. Moreover, we also checked the efficiency of markets on annual basis as well
as for the whole period cumulative.

3.3 Data Collection and Tests

Tests were applied over the data collected for the period of the 5 years ranging from
Jan 2010 to Dec 2014. The collection of data was done based on weekly end points
for the five years. The major reason for selection of weekly end points for the
collection of data instead of averages for whole weeks was because of the concepts of
stock and flow. KSE index points are called as stocks because they are measured at
any one point in time and they should be taken as those points on time rather than
averages as these are used for flows such as income or expenditure.

Since there are many different methods for unit root test, we have used the ADF or
augmented Dickey–Fuller method in this research. This is because it uses parametric
autoregressive structure to capture serial correlation. It is a test for a unit root in time
series. If the statistic used in test is more negative than the critical value then null
hypothesis will be rejected and data will be considered as non-stationary (Hasssn,
Shoaib, & Shah, 2007).

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Testing procedure for ADF is:

ΔPt = αo + α1t+ poPt-1 + ƩpiΔPit-I + Ɛit.

Pt is price at time, ΔP=Pt-P(t-1) coefficients to be estimated, αo is constant and α1t

corresponds to random walk. Po reflects the null hypothesis Ho and H1 is po=Ø.
Here, the more negative the data, more it is prone towards rejection of null hypothesis
and there is a unit root at some confidence level.

4.0 Findings and Analysis:

The research is conducted by taking into account the above research methodology.
However, before applying the test on the data of the KSE 100 Index, we divided the
whole data into six different groups such as the first five groups represent the data of
the five consecutive years i.e. from 2010 to 2014 and the last group comprises the
data of all five years. After the classification of data, Augmented Dickey-Fuller
statistics was applied using the E-Views so that to analyze the unit root variance of
data. Following are the results of data along with the interpretations.

4.1 Time-series analysis:

In 1991 index was launched with a base of 1,000 points. In 2001, it had grown to
1,770 points and by 2005, it had rise steeply to 9,989 points. It then reached a peak of
12,285 in February 2007. KSE 100 index touched the highest ever benchmark of
14,814 points on December 26, 2007, which was a day before the assassination of
prior Prime Minister Benazir Bhutto that plunged the index. The index recovered
rapidly in 2008, reaching new highs near 15,500 April. However, in November 2008
during the global financial crisis index had fallen to 9,187

14
 2010 KSE-100 - Weekly Closing
Price
14000
12000
10000
8000
6000
4000
2000
0
week 1
week 4
week 7

week 16
week 10
week 13

week 19
week 22
week 25
week 28
week 31
week 34
week 37
week 40
week 43
week 46
week 49
week 52
Source: Karachi Stock Exchange

When the financial crisis struck in the year 2008, the market fell from a peak of
15,737 index points to just 9,187 points. The time series analysis of the data for KSE
100 index showed that the market was at the 9347.5 points by the end of the first
week of year 2010, however it showed a growing trend and reached to the level of
12022.46 points by the end of the year. Despite the increase in the market
performance, it was still not able to retain its benchmark position due to political
turmoil and terrorism along with a very high inflation rate of 10.104 (Zucchi, 2012).

2011 KSE-100 - Weekly Closing

Price
14000
12000
10000
8000
6000
4000
2000
0
week 1
week 3
week 5
week 7
week 9

week 17

week 35
week 11
week 13
week 15

week 19
week 21
week 23
week 25
week 27
week 29
week 31
week 33

week 37
week 39
week 41
week 43
week 45
week 47
week 49
week 51

Source: Karachi Stock Exchange

As evident from graph and the previous market performance, the market seems to be
enjoying a recovery stage showing the resilience of stock market of taking major tolls
from external factors especially with the constant terrorism and political influences.

15
Inflation rate got to new height of 13.661 due to the disturbances in the country, due
to which the market had to face many ups and downs and eventually ended up at a
level of 11347.66 in the last week of year 2011 (Tribune, 2012).

2012 KSE-100 - Weekly Closing

Price
18000
16000
14000
12000
10000
8000
6000
4000
week 11
week 13
week 15
week 17
week 19
week 21
week 23
week 25
week 27
week 29
week 31
week 33
week 35
week 37
week 39
week 41
week 43
week 45
week 47
week 49
week 51
week 9
week 1
week 3
week 5
week 7

Source: Karachi Stock Exchange

As can be depicted in the graph, the stock index grew fundamentally at a steady pace
from month to month as compared to previous year stock index growth performance
starting from 11282.01 on January 1st and closed at 16905.33. This indicates of low
pressure from external factors which gave the room for growth such as inflation rate
were 11.005 as compared previous year which was record high of 13.661 and foreign
net investment factor played a role in it, as they were the net sellers of Rs27 million
worth of shares (KSE, 2013).

2013 KSE-100 - Weekly Closing

Price
26000
24000
22000
20000
18000
16000
14000
12000
week 9
week 1
week 3
week 5
week 7

week 11
week 13
week 15
week 17
week 19
week 21
week 23
week 25
week 27
week 29
week 31
week 33
week 35
week 37
week 39
week 41
week 43
week 45
week 47
week 49
week 51

Source: Karachi Stock Exchange

16
As depicted in the graph, the growth in the KSE index was of surge rate as it started
from 16489.99 from January 1 and closed at 25261.14 on December 31. The KSE
100-index increased by 8,356 points year in December 29,2013 and closed at 25,261
as compared to 16,905 points in December 31, 2012. The fiscal year 2013-14 was one
of the best years for Pakistan stock market. This is because KSE 100 index gained 41
percent or 8,356 points in the past 12 months (Shah, KSE-100 index gains 41pc in
FY14, 2014)

From the market analysis it is found that the external factors had a major role to play
in the KSE index, as inflation rate was record low 7.7 %. Moreover, other indicators
also played their part such as strong FIPI inflow of US $117 million that drive
advancement of 3.6% (KSE k. , 2014)

2014 KSE-100 - Weekly Closing

Price
34000
32000
30000
28000
26000
24000
22000
20000
week 9
week 1
week 3
week 5
week 7

week 11
week 13
week 15
week 17
week 19
week 21
week 23
week 25
week 27
week 29
week 31
week 33
week 35
week 37
week 39
week 41
week 43
week 45
week 47
week 49
week 51

Source: Karachi Stock Exchange

The KSE benchmark 100-share index continued its great performance in 2014. The
KSE 100-index increased by 6,645 points year in December 29,2014 and closed at
31,906 as compared to 25,261 points in December 31, 2013.

Although there were external factors such as political conflicts as of between PTI and
PMNL, International oil price vitality but High expectation of rate cut that built
investors’ confidence and constant lower inflation rate of 7.7% gave a surging
fluctuation in the index of KSE. Eventually it reached its previous momentum

17
reflecting the resilience from KSE index of taking any sort of major impacts and
getting back on its tracks (KSE, 2014).

4.2 Unit-root Analysis:

2010-2014

Null Hypothesis: KSE_100_INDEX has a unit root

Exogenous: Constant
Lag Length: 3 (Automatic - based on SIC, maxlag=15)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic 0.844223 0.9946

Test critical values: 1% level -3.455685
5% level -2.872586
10% level -2.572730

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 10/29/15 Time: 15:06
Sample (adjusted): 1/29/2010 12/26/2014
Included observations: 257 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) 0.007704 0.009125 0.844223 0.3993

D(KSE_100_INDEX(-1)) -0.608928 0.063010 -9.664056 0.0000
D(KSE_100_INDEX(-2)) -0.366068 0.069926 -5.235105 0.0000
D(KSE_100_INDEX(-3)) -0.172665 0.062608 -2.757872 0.0062
C 50.26421 168.4273 0.298433 0.7656

R-squared 0.272323 Mean dependent var 87.07712

Adjusted R-squared 0.260772 S.D. dependent var 1191.389
S.E. of regression 1024.337 Akaike info criterion 16.72074
Sum squared resid 2.64E+08 Schwarz criterion 16.78979
Log likelihood -2143.615 Hannan-Quinn criter. 16.74851
F-statistic 23.57682 Durbin-Watson stat 2.033257
Prob(F-statistic) 0.000000

Source: Authors’ Estimations

Test results for the period 2010-2014 showed a value of 0.844223, which is greater
than the critical value of -2.575730 at the 10% level, showing that there is a unit root
in the data of KSE 100 index as test statistics should be less than (-2.567155 at 10%),
(-2.862181 at 5%) and (-3.432059 at 1%) . Thus, the stock market of Pakistan can be
considered as to be still having the weak-form of efficiency.

18
Moreover, the analysis of data both on individual does not follow any trend as evident
from their probabilities, however, on collective level has showed that the stock market
of Pakistan is weak form efficient as well as it follows a trend in indexes. Thus, it can
be observed that despite having a unit root the market seems to be affected by the
previous data, when tested collectively for all years. While on the other hand when
tested individually for all years, result were showing a non trend based movement in
the index points.

Year 2010:

Null Hypothesis: KSE_100_INDEX has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic 0.714054 0.9914

Test critical values: 1% level -3.562669
5% level -2.918778
10% level -2.597285

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 10/29/15 Time: 14:10
Sample (adjusted): 2 53
Included observations: 52 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) 0.032292 0.045223 0.714054 0.4785

C -286.7837 462.8728 -0.619573 0.5384

R-squared 0.010095 Mean dependent var 43.19712

Adjusted R-squared -0.009704 S.D. dependent var 189.0040
S.E. of regression 189.9188 Akaike info criterion 13.36877
Sum squared resid 1803457. Schwarz criterion 13.44382
Log likelihood -345.5881 Hannan-Quinn criter. 13.39754
F-statistic 0.509873 Durbin-Watson stat 1.620608
Prob(F-statistic) 0.478514

Source: Authors’ Estimations

Based on the estimated probability of 0.9914, which is greater than 0.1, thus indicate
that there exists unit root, which means that the time series is found to be non-

19
stationary. Hence the market follows a random walk and is consistent with weak form
of efficient market hypothesis.
According to results of Augmented Dickey-Fuller test, stock markets in Pakistan
showed a result of weak-form efficiency in the year 2010, based on the lagged value
of KSE 100 Index showing probability of 0.4785, which is confirming that there is no
evidence of previous week’s closing price impact on current week’s closing price and
hence the market attempts to capture the impact of information prevailing in its
environment. Thus, we can interpret that the stock market of Pakistan reflects other
sources of information, which dictates its position besides market-based information.

Year 2011:

Null Hypothesis: KSE_100_INDEX has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -2.311842 0.1723

Test critical values: 1% level -3.565430
5% level -2.919952
10% level -2.597905

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 10/29/15 Time: 14:39
Sample (adjusted): 2 52
Included observations: 51 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) -0.194446 0.084109 -2.311842 0.0250

C 2284.959 997.9348 2.289688 0.0264

R-squared 0.098347 Mean dependent var -20.41922

Adjusted R-squared 0.079946 S.D. dependent var 284.2581
S.E. of regression 272.6589 Akaike info criterion 14.09275
Sum squared resid 3642800. Schwarz criterion 14.16850
Log likelihood -357.3650 Hannan-Quinn criter. 14.12170
F-statistic 5.344614 Durbin-Watson stat 2.032553
Prob(F-statistic) 0.025032

Source: Authors’ Estimations

Similar results of Unit root test are found again in 2011 time series, where the
probability value of 0.1723 indicates non-stationary KSE 100 Index series. At same

20
time, there is some interesting finding from the results of Augmented Dickey-Fuller
test, where the first lagged value of KSE 100 Index showing probability of 0.0250
projects that the last week’s closing price does significantly impact on current week’s
closing price, at 5% level of significance; hence the market does not completely
captures the impact of information prevailing in its environment during 2011, so it
may regarded as the year where market more of following a trend. It might be
possible that the collective 2010 to 2014 data set having 2011 time series might be
impacting the estimated coefficients or results.
Year 2012:
Null Hypothesis: KSE_100_INDEX has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.470041 0.5406

Test critical values: 1% level -3.565430
5% level -2.919952
10% level -2.597905

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation
Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 10/29/15 Time: 14:52
Sample (adjusted): 2 52
Included observations: 51 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) -0.030798 0.020951 -1.470041 0.1479

C 556.0698 302.2557 1.839733 0.0719

R-squared 0.042240 Mean dependent var 114.0753

Adjusted R-squared 0.022693 S.D. dependent var 223.4866
S.E. of regression 220.9362 Akaike info criterion 13.67205
Sum squared resid 2391827. Schwarz criterion 13.74781
Log likelihood -346.6373 Hannan-Quinn criter. 13.70100
F-statistic 2.161020 Durbin-Watson stat 2.221700
Prob(F-statistic) 0.147943

Source: Authors’ Estimations

Since the results for Unit Root test and Augmented Dickey Fuller test shows t-
statistics value of -1.4700, which is greater than the critical value at 10% for the test,
hence we have no evidence to reject the null hypothesis that unit root exists in time

21
series of 2012 and the market lagged values are also found to be insignificant. This
depicts that in 2012 again market attempted to incorporate the information into price
changes, confirming the weak form of efficient market hypothesis.

Year 2013:

Null Hypothesis: KSE_100_INDEX has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.177010 0.6773

Test critical values: 1% level -3.568308
5% level -2.921175
10% level -2.598551

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 11/09/15 Time: 23:50
Sample (adjusted): 3 52
Included observations: 50 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) -0.031007 0.026344 -1.177010 0.2451

D(KSE_100_INDEX(-1)) 0.296879 0.140186 2.117755 0.0395
C 774.5622 558.5034 1.386853 0.1720

R-squared 0.103157 Mean dependent var 172.4668

Adjusted R-squared 0.064994 S.D. dependent var 486.5529
S.E. of regression 470.4758 Akaike info criterion 15.20349
Sum squared resid 10403330 Schwarz criterion 15.31821
Log likelihood -377.0873 Hannan-Quinn criter. 15.24718
F-statistic 2.703039 Durbin-Watson stat 1.837652
Prob(F-statistic) 0.077416

Source: Authors’ Estimations

Results for year 2013 showed no evidence for the rejection of null hypothesis as the
test values were 0.6773, which is greater than critical values, showing the presence of
the unit root. Along with the statistical value for the test the lagged values for the test
also showed the values greater than the significance level. Thus, showing the market
as weak form efficient.

22
Year 2014:

Null Hypothesis: KSE_100_INDEX has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.175722 0.6781

Test critical values: 1% level -3.565430
5% level -2.919952
10% level -2.597905

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(KSE_100_INDEX)
Method: Least Squares
Date: 10/29/15 Time: 15:00
Sample (adjusted): 2 52
Included observations: 51 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

KSE_100_INDEX(-1) -0.053566 0.045560 -1.175722 0.2454

C 1669.541 1322.965 1.261970 0.2129

R-squared 0.027437 Mean dependent var 116.5941

Adjusted R-squared 0.007588 S.D. dependent var 536.5925
S.E. of regression 534.5526 Akaike info criterion 15.43916
Sum squared resid 14001580 Schwarz criterion 15.51492
Log likelihood -391.6987 Hannan-Quinn criter. 15.46811
F-statistic 1.382322 Durbin-Watson stat 1.897458
Prob(F-statistic) 0.245387

Source: Authors’ Estimations

Results for year 2014 also showed probability of 0.6781 for the test which higher than
the critical values, showing that there is a unit root in the market data. The results for
the year therefore indicated the weak-form of efficiency in the market.

5.0 Discussion and Conclusion:

The concept of market efficiency helps in understating the current market conditions.
Every investor wants to earn highest possible return and for that many different
researches are conducted to beat the market or earn abnormal return. Markets with
strong form of efficiency allow the players in the market to assess the share prices on

23
their fundamental values and discounted cash flows for projected investments.
Moreover, strong form of efficiency also allows companies to forecast the prices, by
incorporating all risk factors, at which investors and traders would be willing to
purchase securities.

After studying the literature review, it can be understood that the weak form of
efficient market does not allow any investor to earn abnormal returns, as it neither
overvalues nor undervalues any security. Since, the weak form of efficiency depicts
that all the historical data and past share prices shall be reflected into the current share
prices, random walk hypothesis becomes an essential component of the weak form of
efficiency theory. On the other side the paper also highlight the critics of efficient
market that suggest irregularities in the pricing of assets and that most experts have
access to data sources, which they use to get the better returns from their portfolios
that acts against EMH. Moreover to get a better insight of KSE 100 Index, EMH of
Pakistan and world markets was also taken into consideration where some of the
research support and some reject the hypothesis even for same country. Most of the
early researches done in Pakistan stock market used daily or monthly data but this
research uses weekly data to provide new insight. Since, it was not possible to include
all the participants of the market in the analysis, we took only the KSE 100 index for
analysis, as the index is a representation of market.

The aim of this study was to analyze whether stock market of Pakistan i.e. KSE is
information efficient or not to help all the investors of this market. In order to find
efficiency of the market we applied the unit root variance analysis along with the time
series analysis for the years 2010 to 2014. Unit test root is used to test the efficiency
of the market as market efficiency demands randomness (non-stationary) in the price
of stock and unit root investigates whether the time series is non-stationary or
stationary. If the statistic of test is more negative or lesser than the critical value then
null hypothesis will be rejected that means that data is not non-stationary (Hasssn,
Shoaib, & Shah, 2007).

In this study Augmented Dickey Fuller AGF test of unit root was applied on the series
to check for unit root in the series as it uses parametric autoregressive structure to

24
capture serial correlation. The results obtained by augmented-ducker fully test showed
that data of KSE 100 index from 2010-2014 have unit root. This means that data is
non-stationary as market result show permanent result. As probability in all the years
from 2010-2014 is greater than their critical value and t-statistic is greater than ADF
critical value showing data is non-stationary. This showed that there exist a sense of
randomness among stock prices of KSE 100 index or it does follow a random walk
and the market is weak form efficient in all years individually as well as collectively.
Moreover, the time series analysis showed a trend in the market performance, so it
can also be concluded that the market prices of securities and shares can be
determined based on the historical data. When the market was tested individually, the
results of ADF showed that market is weak form efficient, as there existed the unit
root in each year.

However, individual analysis showed that there was no trend in the index movement.
On the other side, the time series analysis showed a bullish trend in overall
performance of the market for the observed time period. As market broke many
psychological barriers and index touched new peaks by the end of this time period.
The major reason for the difference of the results on the individual and collective
scale, in our view, is the trend based movement of index in the year 2011. The results
in 2011 have showed the presence of unit root along with a trend based movement,
which might be a reason for the conflict in the results.

Pakistani market (KSE) is currently being considered among the emerging markets
and since it is been found out that the market is weak form efficient, as SECP has
taken significant steps to make the market more efficient and make individual as well
as institutional investors more responsible. However there is still volatility in the
stock prices ranging from the monopolistic trends in economy, slow communication
processes and information dissipation to the insider trading to selected groups.
Consequently SECP should continuously improve communication, process and
implement strict laws in the market to make market more efficient.

There is still scope for future studies that can overcome the gaps and limitations for
our study. Since there was time limitation we only considered a short time horizon i.e.

25
five years only, however there is still scope for conducting analysis over a long time
series. Moreover we only considered the KSE 100 index in our study as a
representation for Pakistan’s stock market whereas there are other indices that can be
studied such KSE 30 Index and KMI 30 Index. In future, further studies can
overcome these limitations by taking a long term view of market at least 10 years as
well as they can also incorporate a comparison between the all three indices for the
market and their efficiencies as well.

26
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