International Bulletin of Business Administration ISSN: 1451-243X Issue 11 (2011) EuroJournals, Inc. 2011 http://www.eurojournals.

com

Evaluation of Daily Return Behavior of Tehran Stock Exchange (TSE)

Seyed Reza Miraskari Department of Economics, Isfahan University, Iran E-mail: R.Miraskari@yahoo.com Tel: +98-936-9063036 Mehrdad Zolfalizadeh Department of Accounting, Isfahan University, Iran E-mail: Mehrdad_Z1986@yahoo.com Tel: +98-911-2369328 Ashraf Jafari Department of Accounting, Islamic Azad University South Tehran Branch, Iran E-mail: Jafari_Ashraf@yahoo.com Tel: +98-912-7933598 Abstract An efficient market is a market that immediately affects securities price. Efficiency of stock exchange can give rise to optimized allocation of resources, hence it is very important. Objective of this survey is to study daily return behavior of Tehran Stock Exchange in order to confirm or reject market efficiency at weak level. In literature of this survey whenever daily return of stock exchange follows random walk theory during the time, then efficiency of the stock exchange will be confirmed on weak form efficiency. The studying time period of this survey is from 2005-2010. Serial correlation analysis and unit root using the augmented Dicky-Fuller test are used in this survey. Results demonstrate that daily return behavior of Tehran Stock Exchange does not follow random walk theory during the above time period and this means rejection of the research hypothesis, i.e. rejection of weak form efficiency in Tehran Stock Exchange.

Keywords: Tehran Stock Exchange, Capital Market Efficiency, Random Walk Theory, Serial Correlation Test, Unit Root Using The Augmented Dicky-Fuller Test.

1. Introduction
The main task of stock exchange is optimized allocation of scarce financial resources that being efficient is the necessity to obtain this goal. Stock exchange efficiency has a close relationship with existent information in the market and rapid and timely reflection of information on securities prices. Price of securities in such market is closed to its inherent value. In fact in case of efficiency of the capital market, prices of securities are a suitable replacement for their inherent value and these prices are appropriate signs for resource allocation. 102

Given to above issues the main case in this survey is to determine the amount and level of efficiency by means of Tehran Stock Exchange (TSE) index. In order to study the efficiency of Tehran Stock Exchange in this survey we have used serial correlation test and unit root using the augmented Dicky-Fuller test which have numerous applications in researches of efficiency ground. Thus we try in the following to represent the total framework of research by reviewing of literature, background of previous researches and describing of research hypothesis and objectives. Afterwards data analysis is done and conclusion and necessary recommendations will be offered.

2. Research Literature
Subject of stock exchange efficiency is one of the most important subjects of the world great markets at present. An efficient market is a market in which the existent information affects securities prices immediately. Concept of an efficient market presumes that in dealing decisions investors consider all the related information in stock prices. Therefore, the current stock prices include all previous information (like the profit related to the previous season or year) and current information. Necessary conditions to establish an efficient stock exchange have been stated as the following: 1) Easiness of progress and rapid access to information in the market in a complete form for everyone 2) Balance between risk and return 3) Determining of the securities price based on supply and demand forces 4) Lack of severe difference between securities price and their inherent value 5) Liquidity capability of the market 6) Individual inability to one-sided change of prices (Rao, 1989) Indeed these characteristics are the result of the whole competitive market that are appeared because of high similarity of securities transactions to the whole competitive market. So, high degree of efficiency is the result of high degree of closeness of securities' market transactions and whole competitive market. Efficiency of the capital market has various dimensions that will be referred in the following. 1- Information efficiency: by information efficiency we mean that all individuals have access to information and it will affect securities price immediately. 2- Allocative efficiency: the capital market enjoys allocative efficiency when it could invest the existent capitals in plans or companies that offer more return (proportional to risk). 3- Operational efficiency: markets that have higher operational efficiency enjoy more speed and easiness in transactions and transactional costs are at the lowest level. This kind of efficiency is leaded to increase the speed of assets' liquidity (Tehrani, 2009). If there are essential conditions for existence of an efficient market this question is proposed that how much of efficiency is considered. Also it should be noted that the major criterion in evaluation of market's efficiency level is information which has grades and degrees by itself. According to this there are three levels of information efficiency that will be stated briefly. Weak form of an efficient market: information related to previous prices has no impact on evaluation of future changes of prices and the current prices don't reflect the past trend. As a result it is not possible to achieve a better prediction of future trend of prices by analyzing of previous movements of prices. In this state, securities prices don't have historical memory and technical analyses have little application. Semi-strong form efficiency: the current information is a perfect reflection of published information related to each of the securities and the investor can't obtain more return by analyzing of this information. Applying of basic analyses won't be effective in this state too. In other words by showing reaction towards audit reports, financial statements, accounting profit, announcing of each share's profit, announcing of each share's distributed profit, stock analysis and etc we can't obtain a higher investment rate of return. 103

Strong form efficiency: it is the strongest form of an efficient market in which stock prices are totally influenced by information such as public and private information. In this state that the market is efficient in terms of qualitative information, applying of internal information won't be leaded to higher rate of return (Shariat Panahi, 2010). Inefficiency of the market, in general will create many problems for all beneficiaries of the market. One of the important factors in market efficiency is existence of whole competitive conditions, so inefficiency is leaded to creating of non-competitive conditions and consequently unoptimized allocation of resources. Also inefficiency of the stock exchange is leaded to encountering of many accepted companies in the stock exchange with problems and challenges in their financial supply process. This point that the necessity to obtain an optimized level of desirability for investors is existence of an efficient market is the motivation to perform this survey. Thus this question is proposed that can investors of Tehran Stock Exchange achieve the optimized desirability? Or in other words does Tehran Stock Exchange efficient?

3. Objective of Research
Generally the objective of this research could be stated as studying of behavior of stock prices and investors about communities' decisions in order to measure efficiency degree of Tehran Stock Exchange that is stated as below: "Evaluation of daily return of Tehran Stock Exchange to confirm or reject market efficiency at weak level".

4. Research Background
The issue of capital market efficiency has been considered since sixth decade of the twentieth century and by appearing of "chartists" and "inherent value analysts" and representation of their views. Most researchers paid due attention to efficiency of different goods markets in the first half of the twentieth century and most of them showed efficiency of these markets. In sixth decade of the twentieth century few researches were done about the efficiency of the capital market by means of serial correlation methods and run tests. Price indexes had been studied in most of such researches, so evidences about market efficiency were represented. Fama, one of the famous clear-sighted in this regard studied theories related to capital market efficiency in the seventh decade of the twentieth century by offering of three models of Fair Game, Sub Martingale and Random Flow Model. After that various methods were offered to test market efficiency (namazi and shushtarian, 1997). At the end of the seventh decade other methods such as moving average, quadratic predicting model and moving weighted average played an important role in tests related to market efficiency. Studying of securities market efficiency until twentieth century was focused on New York stock exchange and other stocks in America and London stock exchange. Afterwards range of these studies were extended to other stock exchanges in the world because of the importance that efficiency of these markets had in microeconomics policies and economic growth and development. Moreover, efficiency testing methods were improved and researchers tried to apply new statistical and unstatistical methods, so that efficiency tests of stock exchange market entered a new phase at the end of the twentieth century through applying of neural network techniques, resistance level, nonlinear correlation, self-returned vector, multi-variable tests and proposing of predictability of severe and sudden changing degree of prices. Most of the performed studies during this period showed inefficiency of securities market. In the following a number of stock exchange efficiency tests inside and outside of the country will be represented (namazi and shushtarian, 1997). Guidi, Gupta et al (2010) have studied the assumptions of an efficient market in Eastern and Central Europe's stock exchange during 1999-2009 in a research about studying of weak form efficiency in Eastern and Central Europe markets. They used three tests of autocorrelation analysis, 104

random runs test and variance ratio test in order to evaluate efficiency at weak level. Their findings revealed that given to the autocorrelation analysis and variance ratio test Eastern and Central Europe' stock exchange didn't follow random walk theory after being accepted in the European Union, while random runs test showed improvement of the market's position in terms of efficiency. Also they divided the above stock exchange in to different groups through Generalized Autoregressive Conditional Heteroskedasticity in Mean (GARCH-M) model and studied their return and fluctuation separately and concluded that informed investors in some groups would be able to identify bad-valued assets and obtain abnormal return through that. Munir and Mansour (2009) have studied stock transactions' index behavior in Kualalampour stock exchange from Jan 1980 to Aug 2008 by means of two auto-regression models with a unit root test in a research entitled "Is Malaysian stock exchange efficient? Evidences from unit root test" and results showed confirmation of hypotheses related to an efficient market at weak level. Metghalchi, Chang and Marcucci (2008) have studied productivity of some commercial technical rules in Sweden market during the period 1986-2004 in a research entitled "Is the Swedish stock market efficient? Evidences from some simple commercial rules". They studied the return resulted from daily buying and selling of securities during the above period and results showed that irregular return of daily buying and selling of securities was nonzero and as a result one of the assumed hypotheses of an efficient market was rejected. In 1988 Fama and French stated that an efficient stock market has random movement characteristics of unit root which shows that it is not possible to predict stock exchange return based on historical observations. If stock prices follow a random walk process, each shock would be durable in the stock prices and there would be no tendency towards prices' return to precious level during the time. Random walk characteristic means that future stock returns after that stock price is unpredictable based on previous observations. Ball and Brown (1968) have studied the relation between accounting profit and profit of each share with the stock price in their research entitled "a primary evaluation about accounting profit". According to efficient market hypothesis, announcing of accounting profit should not affect the stock profit because prices include all of the existent information. Results of this research show that there is a relation between accounting profit and stock prices. Sinaee and Mahmoudi (2006) have studied sample irregular return mean during the years 19942002 in a research entitled "studying the news related to stock split and reward stock on stock return in Tehran Stock Exchange". Methodology of this research was exactly adopted from Messrs Fama, Fisher, Jenson and Roll (F.F.J.R) who had studied the efficiency of New York Stock Exchange at semistrong level. Obtained results of this study showed existence of irregular return around societies and this rejects semi-strong form of efficiency in Tehran Stock Exchange. In 1991 a study about distribution function of stock prices' fluctuations was done in Tehran Stock Exchange. The intended time period in this research included two periods from 1975 to 1979 and 1986 to 1990. Given to the obtained results distribution of price fluctuations in stock exchange had projection more than normal distribution and inefficiency of the market was shown at weak level (Emami, 1991). A similar research was performed in 1993 about 17 companies and in time period of 1990 to 1992. In this research runs test was applied and the difference between real and expected runs for different companies was obtained 2.5 to 6.1 which revealed inefficiency of the market at weak level because of being higher than 1.96 (Nasrollahi, 1993). Another research was done in 1995 through autocorrelation methods and runs test and by means of weekly stock price of 50 companies for the time period of 1990 to 1994. Results of this research showed inefficiency of Iran's stock exchange during the above time period (Fadaeenejad, 1995). In 1996 another research was done through serial correlation methods, normality tests, filter procedure and buying-maintaining method. Data under study was daily and weekly prices of 40 105

companies during the years 1989-1995. Obtained results of this research revealed inefficiency of Tehran Stock Exchange at weak level too (Namazi and Shushtarian, 1997). As it is observed, efficiency of Tehran Stock Exchange has been studied during the two last decades of the twentieth century by applying of different methods and all researches show that Tehran Stock Exchange has no efficiency until 2002 even at weak level. Various indicators of stock exchange activity had a decreasing process in the second half of the year 2005 which were affected by different internal and external events and irregular increasing of indexes during previous years. Anyway, policies and attempts of the government and the Stock Exchange Organization have reduced the speed of decreasing process of stock exchange activity's indexes since Nov 2006. While the general index was arrived to 9.459 units at the end of 2006, it passed the limit 10000 during 2007. Also considerable reduction of stock transactions in 2006 gained relative balance given to the above effective actions in 2007. The following are among the main actions that have been leaded to fundamental changes in financial analyses' results after the year 2005 and are the main reason for performing of this research: Approving of securities market rule of the Islamic Republic of Iran Constitution of supreme council of stock exchange Constitution of stock exchange organization Constitution of Tehran Stock Exchange (public corporation) Constitution of central deposit company of stock exchange and funds liquidation

5. Research Methodology
Statistical population of this research includes accepted companies in Tehran Stock Exchange that daily return of Tehran Stock Exchange from 13.3.2005 to 8.3.2010 has been used in order to study efficiency at weak level. These statistics are adopted from Tehran Stock Exchange website (www.seo.ir). Hypothesis of this research is: Daily return of Tehran stock exchange follows random walk theory. Hypothesis of this research studies market efficiency at weak level, so that if daily return of Tehran Stock Exchange has serial correlation or it has stationary process then efficiency of Tehran Stock Exchange won't be proved at weak level. Therefore we introduce serial correlation method and unit root using the augmented Dicky-Fuller test. 5.1. Serial Correlation Test Serial correlation is one of the statistical tools to calculate dependency of one variable with its previous amounts. In other words, it is possible to calculate and evaluate the relation between stock return in the current period with previous periods by means of serial correlation that is calculated as the following: =1 (rt r) (rt-k r ) = =1 (r r ) 2 That k is serial correlation of stock market return coefficient with k lag. N is number of observations, rt is stock market return during period t, rt-k is the stock market return during period t-k, is stock market return average and k is the intended lag. So p p t 1 rt = t = ln pt ln p t 1 pt 1 In which pt is equal to stock exchange market's index in t period and pt-1 is equal to stock exchange index in period t-1. The purpose of serial correlation test is to determine whether serial correlation among the intended coefficients is different from zero significantly or not. If stock market return follows serial correlation statistically (k is different from zero significantly), then efficiency 106
n t k n t k

hypothesis related to weak form of the market will be rejected. Ljung-Box statistic (Q) has been applied in order to test whether all correlations are simultaneously equal to zero or not. If statistic Q is different from zero significantly, then it means that the intended sample has serial correlation. As a result the null hypothesis which shows independency of the market return will be rejected (Guidi et al, 2010). 5.2. Unit Root Test Using the Augmented Dicky-Fuller Stationary Concept If sequence rt is a strict stationary, then common distribution of (rt1, rt2,, rtk) would have no difference with common distribution of (rt1+s , rt2+s , , rtk+s). It means that time change factor has no impact on common distribution function. Because of difficulty of strict stationary tests, another form of stationary called weak stationary is usually used. If sequence rt is a weak stationary, its average and also covariance among its lags will be independent of time and it just depends on the studying length in the sequence: E(rt)= COV(rt , rt-1)= Stationary Test Applying of ordinary least squares estimation method (OLS) in experimental activities presumes that variables of the used time series are static. On the other hand, the predominant belief is that many time series variables are not static in economy. Thus it is necessary to be assure of their being stationary or unstationary before using such variables. The first step to determine stationary of a variable is observing of time series diagram of that variable. Of course, there is this possibility that a time series variable which has time trend be static simultaneously around such time trend. Here the topic of certain and random trends is proposed. Variables have certain time trend that their total movement path is predictable during the time, but if the time trend of a variable is changed randomly during the time in a way that its movement path is not predictable it is said that this variable has random process (Johnston, 1998). Kinds of Stationary Tests Stationary test based on correlogram and Dicky-Fuller unit root tests and augmented Dicky-Fuller test: Unit root test is one of the most common tests that is used to determine stationary state of a time series process. For the following first order autoregressive process: yt = yt-1 +ut We form the following hypothesis testing to test whether time series yt has unit root or in other words it is static: H0: = 1 H1: < 1 We can estimate parameter through ordinary least squares (OLS) method as the following:

Basis of unit root test is based on the assumption that when =1, first order autoregressive process yt = yt-1 +ut is unstationary. Thus if coefficient of the above equation is estimated through ordinary least squares (OLS) method and its being equal to one is tested, we can prove being stationary or unstationary of a time series process. The problem that exists in performing of such test is that represented t statistic by ordinary least squares (OLS) method under the accuracy of hypothesis =1 hasn't common distribution t even in large samples and so it is not possible to use critical quantities of t to perform testing. 107

Estimator is in a way that when n is increased, probability distribution of statistic ( - ) tends towards normal distribution with average amount of zero and variance 1. Statistic ( - ) does not have normal limit distribution under the assumption that H0 is correct, i.e. =1 and has no standard shape. Hence we can not use represented critical quantities by normal distribution or t in order to do this test. Dicky-Fuller has suggested the following statistic based on estimator in order to perform the above test: n( The above statistic is a limit distribution and its critical quantities for unit root test or =1 have been obtained by help of simulation methods. Under accuracy of the null hypothesis =1, common calculated amounts of statistic t through ordinary least squares (OLS) method are known as statistic and instead of t-test we should use DickyFouler test. Dicky-Fuller critical amounts table regulated by McKinnon has been expanded through simulation of Mont Carlo. If modulus of the calculated statistic is larger than the critical amount modulus, then H0 is rejected, i.e. series is not stationary and if it is lower, H0 will be accepted and series has random walk process and is stationary (Harris, 1992b). Augmented Dicky-Fuller Test In order to test stationary state first we supposed that the intended time series had a first order autoregressive process and then we tested hypothesis =1 according to that. Now if this hypothesis is not correct and the studied time series has p-order autoregressive process, the estimating relation for test won't have accurate dynamic definition and it will be resulted in autocorrelation of regression disturbance terms. When disturbance terms have autocorrelation it is no longer possible to use DickyFuller test for stationary state, because limit distribution and obtained critical quantities through DickyFuller are not correct in this state. But if disturbance term ut are autocorrelated, limit distribution and obtained critical quantities are correct in case of using of augmented Dicky-Fuller model. By assuming that disturbance term ut related to the following relation: yt = + t + yt-1 + ut has a self-distributed stationary process from p-order as below: ut = 1ut-1 + 2ut-2 ++ put-p + t In which t is a IID (Independent Identically Distribution) process (that is all t are distributed similarly and independent from each other). Now if we replace the above relation in the previous relation we will have: yt = + t + yt-1 + 1ut-1 + 2ut-2 ++ put-p + t If hypothesis =1 is accurate, it is concluded that ut = yt + yt-1 and so we can write the previous relation as below: yt = + t + yt-1 +
1(yt

+ yt-1) ++

(yt-p yt-p-1) +

= + t + yt-1 + 1yt-1 ++ pyt-p + t i = + t + yt-1 + iyt-1 + t Dicky-Fuller shows that calculated statistic t has the same non-standard limit distribution in order to test =1 or in other words =0 in the above relation. In practice number of terms along with the lag that must be considered in the above relation are usually determined empirically because order of self-distribution process related to disturbance term is not specified. The purpose is to add terms with lag to the relation to the extent that t has no correlation. The null hypothesis is =1 or =0 i.e. existence of unit root and the process is not stationary. In order to determine the estimation of a relation like the above one it is sufficient to consider Durbin-Watson statistic. If existence of autocorrelation among disturbance term is established then we use yt-1 108

sentences to remove autocorrelation. At the same time we can express ideas based on Lagrange coefficient test about existence of correlation among disturbance term (Noferesti, 2000; Harris, 1992a).

6. Evaluation and Analysis of Model

Studying the efficiency of stock market at weak level has been done for the first time by Eigen Fama that is one of the most known tests in the field of market efficiency at weak level. Fama test was about daily return of 30 Dowjones industrial stock which tested distances from 1 to 10 by means of serial correlation analysis. In this survey daily return of Tehran Stock Exchange until 25 lags are applied, thus we have used market daily return for five years or 1153 days and subtracting of holidays that correlation between return of each day with the previous day are studied. We determine market return process during this time period in this survey and then we analyze it. This process is shown in figure (1). The first used method to test stock exchange efficiency is serial correlation test with 25 lags. Results of this test are illustrated in table (1). Significance of autocorrelation coefficients with lags of 1 to 25 and simultaneous significance of these coefficients by Ljung-Box and Box-Pierce test demonstrate that return of Tehran Stock Exchange has serial and predictable correlation during the time through technical tools.
Figure 1: Return trend of Tehran stock exchange for 1153 days

Another method to study efficiency of Tehran Stock Exchange is to apply unit root test using the augmented Dicky-Fuller method. Output of Microfit software shows that white noise of disturbance term (t) is occurred in the second interval based on Schwartz Bayesian Criterion (SBC) and HannanQuinn Criterion (HQC), that is they have the highest amount in the second lag. Dicky-Fuller modulus (13.8282) in this lag is larger than modulus of critical amount of this statistic (3.4161) on confidence level 5% which shows daily return variable has been stationary and does not follow random walk process. Return to average variable that is stationary has been explained in some of the performed researches about the capital market behavior and being stationary does not necessarily mean inefficiency. However, if market return variable is stationary, we can expect to obtain abnormal profit from the market by technical analyses. It is noteworthy that augmented Dicky-Fuller test in both states of with intercept and without trend and also with intercept and with trend has similar results, i.e. daily return variable has stationary process in both states.

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Table 1:
order 1 2 3 4 5 6 7 8 9 10 11 12 13

Results of serial correlation test until 25 lags

Autocorrelati on coefficient 0.41115 0.25308 0.20270 0.17053 0.13926 0.13563 0.095704 0.12053 0.15222 0.17378 0.14254 0.15380 0.12755 Box-Pierce statistic (0.000)194.7392 (0.000)268.5268 (0.000)315.8583 (0.000)349.3606 (0.000)371.7007 (0.000)392.8920 (0.000)403.4436 (0.000)420.1782 (0.000)446.8711 (0.000)481.6608 (0.000)505.0657 (0.000)532.3158 (0.000)551.586 Ljung-Box statistic (0.000)195.2468 (0.000)269.2910 (0.000)316.8285 (0.000)350.5059 (0.000)372.9823 (0.000)394.3216 (0.000)404.9561 (0.000)421.8169 (0.000)448.7868 (0.000)483.9421 (0.000)507.6136 (0.000)535.1983 (0.000)554.1880 order 14 15 16 17 18 19 20 21 22 23 24 25 Autocorrelation coefficient 0.10547 0.12166 0.11953 0.11563 0.13031 0.13162 0.11474 0.076587 0.091000 0.072527 0.069452 0.067129 Box-Pierce statistic (0.000)563.8746 (0.000)580.9256 (0.000)597.3840 (0.000)612.7873 (0.000)632.3484 (0.000)652.3063 (0.000)667.4714 (0.000)667.2285 (0.000)683.7683 (0.000)690.3745 (0.000)695.9513 (0.000)701.1226 Ljung-Box statistic (0.000)567.1842 (0.000)584.4901 (0.000)601.2093 (0.000)616.8704 (0.000)636.7765 (0.000)657.1043 (0.000)672.5642 (0.000)679.4587 (0.000)689.2011 (0.000)695.9536 (0.000)701.6385 (0.000)706.9541

7. Conclusion
Daily return behavior of Tehran Stock Exchange (TSE) has been studied in this survey through serial correlation test and unit root test using the augmented Dicky-Fuller method. Results of both tests show that daily return behavior of the market does not follow random walk theory and has the characteristic of return to average and it is possible to apply technical transactional principles to predict prices and have access to abnormal profit since effect of price shocks in stationary processes are transient. We can expect that using of such tools is effective in creating of additional return. Thus hypothesis of this survey which says daily return of Tehran Stock Exchange follows random walk theory is rejected and we can state that Tehran Stock Exchange has no efficiency.

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