MBA Project PEREZ A. ANYUMBA.

69 Pages·2010·0.39 MB·English

AN EMPIRICAL TEST OF THE RANDOM WALK MODEL
FOR THE NAIROBI STOCK EXCHANGE (NSE)

BY:
PEREZ A. ANYUMBA.

A PROJECT SUBMITTED IN PARTIAL FULFILMENT OF
REQUIREMENT FOR THE AWARD OF MASTER OF
BUSINESS ADMINISTRATION (MBA) DEGREE.
SCHOOL OF BUSINESS,
UNIVERSITY OF NAIROBI.

NOVEMBER 2010.
DECLARATION
I the undersigned declare that this research project is my original work and has not been
submitted to any college, institution or University other than the University of Nairobi for
academic purposes.

Signed: _______________________ Date: ________________
PEREZ A. ANYUMBA
D61/71217/2008

This research project has been submitted with my approval as University supervisor.

Signed: _______________________ Date: ________________
MR. MOSES ANYANGU
LECTURER, DEPT. OF FINANCE AND ACCOUNTING
UNIVERSITY OF NAIROBI.

DEDICATION
This study has been dedicated to my dear husband Robert, my son Albert, my daughter
Mical and my sister Rebecca for their love, understanding and patience when I could not
be with them because of my studies. May they receive God’s blessings in abundance.

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ACKNOWLEDGEMENT
First and foremost I thank God, for giving me the strength to go through this demanding
and rewarding exercise. I appreciate and wish to extend my best wishes and gratitude to
all whose assistance and encouragement enabled me to complete this project.
Special thanks to my supervisor, Mr. Moses Anyangu for his invaluable input, dedication
to this work, expert support, knowledge , motivation, patience and encouragement. God
bless you.
I would like to thank my family for standing by me throughout the challenge. Special
thanks to my son Albert and daughter Mical for putting up with my absence. My loving
husband Robert Otom and my sisters Rebecca, Miriam and Lillian for your support
through the years. God bless you abundantly. To my friends Isaac and Robert Mule for
your faithful academic support. God bless you. To NSE that provided me with the needed
data for this project, I say thank you very much.
I am grateful to my colleagues for the various information and contribution in whichever
way, especially Peris Kiguta, may God bless you, not forgetting my different groups,
Young Professionals (OLQP church) and Success Island members.
Finally, my sincere appreciation to my late parents, I will always be grateful for your
noble support in bringing me up to the person I am. God bless you.

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ABSTRACT
It is usually believed that the markets in developing and less developed countries are not
efficient in semi-strong form or strong form. Efficient capital market is one which prices
fully reflect the available information. An important implication of efficient market
theorists is that stock market should approximately follow a random walk. The Random
walk Model states that present market price is the best indicator of the future market price
with an error term that is stochastic in nature. Hence the next period’s price is anybody’s
guess.
The purpose of the study is to empirically test whether NSE indices follow random walk
or not, that is to determine whether NSE conforms to the efficient market hypothesis or
not. If NSE follows random walk, the share prices cannot be predicted or forecasted using
predictive model developed using the historical data. Hence NSE will be classical
example of efficient capital market in developing economy in the weak form.
The research study assessed the variance ratio of NSE 20 share index and NASI at lag q
and corresponding Z-statistic for different specification of the error Et term behavior
between operational periods; 1st March 2004 to 30th April 2009 and 1st January 2008 to
30th April 2009 respectively. It adopted a model in random walk first designed by
Bachelier in 1990 but modified by substituting stock prices by NSE share indices. The
study population will comprise of the NSE 20 share indices points and NASI. The study
used secondary data collected from NSE daily index return files, daily newspapers and
internet.
NSE was found to follow random walk, hence according to this project; it has been
classified as efficient market in a developing economy under weak form of Market
Efficiency. The information is significant to different stake holders in making informed
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decisions in relation to the share prices, better policies to regulate the players in CMA,
proper planning and also form a basis of further research on the subject.

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LIST OF ABBREVIATIONS
AIG (EA) - American Insurance Group (East Africa)
AIMS - Alternative Investment market Segment
ANN - Artificial neutral network
ANOVA - Analysis of Variance
ARIMA - Auto-regression Integrated Moving Average
ASE - American Stock Exchange
ASMs - Asian stock markets
BSE - Bombay stock exchange
CRSP - Centre for research in security prices
CSE - Chittagong Stock Exchange
D/N - Daily Nation
DSE - Dhaka Stock Exchange
DW -Durbin Watson Test
ESMs - Emerging Stock Markets
FMA - Fixed length moving average
GSE DSI - Ghana Stock Exchange Databank stock Index
ISE - Indian stock exchange
ISM - Indian stock market
NASI - Nairobi Stock Exchange All Share Index
NYSE - New York Stock Exchange
NBK - National Bank of Kenya
NSE - Nairobi stock Exchange
P/E - Price per Earning Ratio
SKM - South Korean market
USSM - United States Stock market
VMA - Variable length moving average
ZSE - Zimbabwe Stock Exchange

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LIST OF TABLES
Table 4.2.1: Weekly values of NSE 20 share indices for null hypothesis of Random Walk
Model.
Table 4.2.2: Weekly values of NASI for null hypothesis of Random Walk Model.
Table 4.2.3: Monthly values of NSE 20 share indices for null hypothesis of Random
walk Model.
Table 4.2.4: Monthly values of NASI for null hypothesis of the Random Walk Model

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LIST OF FIGURES
Figure 4.3.1: NSE 20 share weekly indices based on Monday’s reports of the first twenty
weeks (1st March 2004 to 30th April 2005)
Figure 4.3.2: NSE 20 share weekly indices based on Monday’s reports of the last twenty
weeks (1st March 2008 to 30th April 2009)
Figure 4.3.3: NSE 20 share monthly indices based on the last working day of the month
for the first one year period for the study (1st March 2004 to 30th April 2005)
Figure 4.3.4: NSE 20 share monthly indices based on the last working day of the month
for the last one year period for the study (1st March 2008 to 30th April 2009)
Figure 4.3.5: NASI monthly indices based on the last working day of the month (1st
January 2008 to 30th April 2009)

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TABLE OF CONTENTS

DECLARATION............................................................................................................ii
DEDICATION................................................................................................................iii
ACKNOWLEDGEMENT..............................................................................................iv
ABSTRACT....................................................................................................................v
LISTOF TABLES............................................................................................................ix
LIST OF FIGURES..........................................................................................................x

CHAPTER ONE: INTRODUCTION...........................................................................1
1.1 Background to the study.........................................................................................1
1.2 Statement of the Problem.......................................................................................5
1.3 Research objective..................................................................................................8
1.4 Importance of the Study........................................................................................8

CHAPTER TWO: LITERATURE REVIEW.............................................................10
2.0 Introduction............................................................................................................10
2.1 Theoritical Literature..............................................................................................10
2.1.1 The Genesis of random in stock prices................................................................10
2.1.2Theory of efficient market hypothesis..................................................................11
2.1.3 The Dumb Agent Theory.....................................................................................11
2.2 Empirical Studies....................................................................................................12
2.2.1 Empirical evidence of independence...................................................................12
2.2.1 Empirical evidence against independence...........................................................15
2.3 Common Predictive Techniques.............................................................................21
2.3.1 Chartist or technical theories...............................................................................22
2.3.2 Fundamental or intrinsic value analysis..............................................................23
2.4 Historic Information …………………………………………..……………….…24
2.4.1 New Information………………………………………………………………...24
2.5 The interaction between weak form market efficiency and the emerging
markets……………………………………………………………………………..…26
2.6 Criticism of random walk…………………………………………………………27
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2.7 Conceptual framework……………………………………………………………28
2.8 Conclusion from Literature Review………………………………………………30

CHAPTER THREE: RESEARCH METHODOLOGY.........................................32
3.0 Introduction............................................................................................................32
3.1 Research Design.....................................................................................................32
3.2 The target population..............................................................................................32
3.3 Sample....................................................................................................................33
3.4 Data type and Collection Techniques………………………………………..……33
3.5 Data Analysis………………………………………………………………….......33

CHAPTER FOUR: DATA ANALYSIS,RESULTS AND DISCUSSION.................35
4.0 Introduction............................................................................................................35
4.1 Data Analysis..........................................................................................................35
4.2 Tables and Analysis of Results...............................................................................36
4.3 Line graphs for NSE 20 share index and NASI for portions of the study period...44
4.4 Summary of Findings.............................................................................................48

CHAPTER FIVE: CONCLUSIONS AND RECOMMENDATIONS.......................50
5.0 Introduction............................................................................................................50
5.1 Conclusions............................................................................................................50
5.2 Recommendations..................................................................................................51
5.3 Limitation of the study...........................................................................................51
54 Suggestions for Further Research............................................................................52
REFERENCES...............................................................................................................53
APPENDIX..................................................................................................................58

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