УДК 332 JEL code G15 MOMENTUM STRATEGY AND BOMBAY STOCK EXCHANGE Polak Petr (Corresponding author) FBEPS, University Brunei Darussalam (Brunei Darussalam) Dr., Ph.D., Associate Professor

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УДК 332 JEL code G15 MOMENTUM STRATEGY AND BOMBAY STOCK EXCHANGE Polak Petr (Corresponding author) FBEPS, University Brunei Darussalam (Brunei Darussalam) Dr., Ph.D., Associate Professor Ejaz Abduallah School of Business and Economics, Swansea University (United Kingdom) M.Sc., Ph.D. Student Abstract. Short term momentum effect claims that recent past winners tend to outperform the market whereas recent past losers tend to underperforms the market. Therefore by definition it challenges the efficient market hypothesis, which is of the view that future returns cannot be predicted by using past returns. This study examines whether short term momentum effect challenges the efficient market hypothesis or not. Momentum effect has been found in almost all the stock exchanges in the world and documented in the financial literature by many well-known scholars. For this purpose, Bombay Stock Exchange (BSE) has been chosen and stock prices of BSE 100 index have been downloaded for the period starting from 24 June, 2006 and ending on 24 June, 2011 to perform momentum calculations. BSE has been selected because of its rapidly growing nature. Many leading articles have mentioned Bombay Stock Exchange as one of the fastest emerging capital stock market in the world. Short term momentum anomaly has been found in Bombay Stock Exchange. Price momentum strategy gives abnormal returns, if implemented in BSE. Average monthly return from BSE is 12.05% which is higher than many leading stock markets of the world for instance NYSE, AMEX, and LSE etc. It is also noticed that winners are outperforming the losers. The above findings are in line with the findings of existing literature. Trading volume based momentum strategies only work when high trading volume and low trading volume based strategies will be used in combination with each other. The notion that BSE is an emerging market has also been tested. Returns of momentum strategy from Bombay Stock Exchange and Karachi Stock Exchange have been compared and found that BSE gives more returns than KSE. It has been confirmed from this finding that BSE is the emerging stock market in the region. Keywords: Bombay Stock Exchange, Karachi Stock exchange, efficient market hypothesis, momentum strategies, zero cost momentum portfolio, systematic risk. 1. Introduction It has been argued time and again that whether capital markets are efficient or not. The efficient capital market phenomenon rose to surface when Fama in 1970, in an article, wrote about efficient market hypothesis. Fama was the first author who 1 formally developed the efficient capital market phenomenon and came up with the term efficient market hypothesis (EMH). He divided EMH into three forms i.e. weak form EMH, semi strong form EMH and strong form EMH. According to EMH, markets are efficient and when any new information hits the market, prices absorb this information and reflection of this particular new information can be seen in the prices. Similarly new information is available to all the investors at the same time, free of cost and past returns cannot be used to predict future returns. As a result, no group of investors can earn abnormal returns and is able to beat the market consistently. EMH assumes that the buyers and sellers in the capital market are rational; one piece of information is independent of other piece of information and claims that past prices cannot be used to predict future prices. The proponents of EMH believe that an investor cannot predict future prices on the basis of past prices of stocks or earn above average abnormal returns unless this investor possesses any inside information. Since EMH s rise in the financial literature, the opponents of the EMH are claiming that futures returns can be predicted by using past returns information. There are many phenomena that have been introduced by the opponents of efficient market hypothesis to challenge EMH. These phenomena are known as anomalies in financial literature. Some of the famous anomalies are long term reversals, short term momentum effect, post earnings announcement drifts etc. However, the topic for discussion here is short term momentum effect. There is a lot of empirical evidence in the literature of finance that has proved the existence of momentum effect in capital markets. Momentum anomaly has been confirmed in NYSE and AMEX in USA by Jegadeesh and Titman (1993). Its presence has also been confirmed by Rouwenhorst (1998) in twelve stock markets of Europe. Chui, Titman, and Wei (2000) also confirm the momentum effect in six Asian stock markets. Rouwenhorst (1999) conducted his study on momentum on twenty emerging stock markets and found that momentum is present in 17 out of twenty economies. Griffin, Ji, and Martin (2002) conducted study on momentum on forty stock exchanges which belong to Africa, America, Asia and Europe and found the existence of momentum in all forty stock markets. Above empirical evidence confirms that momentum effect is present in almost all stock exchanges from around the world. In some countries it is weak and in some countries it is strong. This study has been motivated by the notion that whether short term momentum effect challenges the efficient market hypothesis or not. Bombay Stock Exchange has been chosen to examine the above statement and index is BSE 100 index. Prime reason to choose BSE for momentum study is that there is no such direct short term momentum effect study has been conducted on above mentioned stock exchange. Although Griffin, Ji, and Martin (2002) and Rouwenhorst (1999) have done this type of study on Bombay stock market. But, it was not a full fledge study. In both studies there were 39 and 19 other stock markets included by the authors to examine the momentum effect. Most of the momentum work has been done on stock markets of USA and Europe, for instance, Ellis and Thomas (2004) sought the presence of momentum effect on London Stock Exchange. Moreover, it is necessary to seek whether momentum phenomenon exists in the BSE 2 or not. Furthermore, BSE is a rapidly growing and emerging stock market in the world. It is interesting to see that up to what extent price momentum strategy can be exploited in BSE to earn positive abnormal returns. In addition to this, it is also essential to examine whether momentum effect is strong or weak relative to momentum effect in other developing stock markets. All above reasons created a space in financial literature to carry out momentum study on Bombay Stock Exchange. Apart from all these reasons, it also interests to see the comparison between the returns from price momentum strategy of two developing but growing stock exchanges i.e. Bombay Stock Exchange and Karachi Stock Exchange. 2. BSE and Indian economy Bombay Stock Exchange is the prime stock market of India and one of the rapidly growing markets from Asia which is ready to mark itself as one the biggest global stock market on the map of the world. Bombay Stock Exchange limited which is known as, BSE in recent times, was established as The Native Share & Stock Brokers' Association in It is the oldest stock exchange in Asia. It has been giving its services to corporate sector of India for past 135 years. As of February 2010, total capitalization of stocks listed on BSE stand on USD 1.28 trillion. Its total capitalization takes BSE in the top 10 list of global stock exchanges based on capitalization. Total of 4900 companies have been listed on the BSE, which makes it first stock exchange in the world to register that many companies and 5th in the world to handle and manage most number of daily transaction through BOLT system. BOLT is an abbreviation of BSE online trading system and it was developed to handle hundreds of thousands of transactions efficiently and effectively. Indian economy in general and Indian stock market in particular is ideal to invest for domestic as well as international investor due to number of reasons. Indian stock markets in particular and Indian economy in general are growing at a very rapid rate. It can be confirmed from various reports issued by banks like Asian Development Bank. In a report Asia Capital Markets Monitor issued by Asian Development Bank, ASB claims that the equity market in India is booming. Equity market in India now stands at $600 bn and it is the third largest equity market in Asia after China and Hong Kong. It is very encouraging that Govt. of India understands that their capital markets and economy are growing and they are supporting this growth by making such changes in the rules and regulations which are beneficial for the domestic as well as international investors. World Bank announced that in 2010 India would grow at the rate of 8%. This figure is very encouraging for India as China is growing at the rate of 7.7% and if India would have achieved that rate, it would leave China far behind in terms of growth. Many credible and leading indices such as ABN Amro's Purchasing Managers' Index (PMI), UBS' Lead Economic Indicator (LEI), and Nomura's Composite Leading Index (CLI) are of the view that hiring in India is increasing and cement and steel industry is progressing. The size of Indian economy is US$ 1.3 trillion which makes it the 8th biggest economy of the world. Future predications about Indian economy are very courageous. It is predicted that by 2013 Indian economy crosses the mark of US$ 3.8 trillion and it will make it the third largest economy in the world after United States of America and China. Currently, India is 3 growing at the rate of 8.75% and it is also predicted that, for the next ten years India is going to grow at the rate of 9% to 10%. India is the second largest population based country in the world. The average age in country is 25 years or below. Therefore domestic as well as foreign industry can take the advantage of youth in terms of using them to bring innovation, generate new ideas and start new businesses. This large population can also be used as demographic dividend. As, due to large number of population, supply of labour is higher, this will lower the demand and ultimately lower the wages. By paying low wages, producers will be able to sell products at lower prices which in turn boost the overall economy in general and stock market in particular, because, more companies would like to take benefit of lower wages, so more companies will be registered by Bombay stock exchange. This demographic dividend could be prime reason to attract foreign investment in India by India. 3. Literature review This literature review sheds the light on momentum strategies that are being followed in the present universe of stock markets. The main focus of this review is on price momentum strategies but literature on earnings momentum strategies in connection with price momentum strategies have also been considered. Short term momentum effects poses great challenge to efficient market hypothesis. This literature examine momentum phenomenon for the stock markets of Australia, Asia, Africa, Europe, Middle East and US. Jegadeesh (1990) and Lehmann (1990) document the proof of short term reversal. Authors in their separate papers show that stocks that yield positive returns in their previous week or month of trading generate sufficient above average positive returns in future. But these abnormal returns cannot be attributed to the overreaction of investors rather these returns are the result of pressure of short term price movements or shortage of liquidity in the stock market. Jegadeesh and Titman (1991) support this interpretation by providing the evidence on the relationship between short-term return reversals and bid ask spread. Lo and MacKinlay (1990) also verify the evidence provided by Jegadeesh (1990) and Lehmann (1990) that abnormal returns are the result of late reaction of stock to other factors and it is not overreaction that causes abnormal returns. However, short term reversals considered being the opponent of short term momentum effect but it was later denied by Jegadeesh and Titman (1993). Recently momentum strategies have received considerable attraction in trading literature but early literature focuses more on buying past winners and selling past losers. As Levy (1967) argue that stocks that performed well in last 27 weeks have earned significant abnormal return. Jegadeesh (1990) and Lehmann (1990) argue that despite the significance of momentum strategies most mutual fund manager still use old strategies that they tend to buy such stocks that have performed well in the past quarter. Jegadeesh and Titman (1993) examine the impact of short-term momentum effect on stock markets. They take returns from two stock markets in United States i.e. NYSE and AMEX. They collect stock returns for the period starting from 1965 and ending on They adopt strategy in which they buy such stocks that have 4 performed very well in the past and sell those stocks that have performed worst in the past. They reach to a conclusion that if such stocks are to be held for the period of 3 to 12 months, they produce positive returns. However, they find that profitability is not the result of systematic risk but it is due to reaction of stock prices to ordinary factors. Thereby they refute the findings of Jegadeesh (1990) and Lehmann (1990), Jegadeesh and Titman (1991) and Lo and MacKinlay (1990). However, this delay or reaction to price movements still exists but it can be attributed to firm-specific information. They find that price changes that become predictable after the holding period of 3 to 12 months are not permanent, so the predicting power of momentum strategy is limited to 12 months. They also uncover the fact that stocks that earned abnormal return from momentum strategies tend to incur losses after two years of the formation of a portfolio. An interesting finding comes to know that similar trends have been observed by author in earning momentum strategies. One explanation they find in explaining profits from momentum strategy is that investors who buy past winners and sell past losers cause the prices to deviate from their base price on temporary basis and create overreaction in the stock market. This finding is in line with the finding of DeLong, Shleifer, Summers, and Waldman (1990) who see the impacts positive feedback traders on the prices of stock market. They believe that market does not overreact to the information which has short-term impact on the firm but market does react to the information which has long term impact on the firm s future. They further argue that this overreaction or under reaction is completely and solely dependent on nature of information and how investor perceives it. For example, one investor may think of earnings forecast as big news and overreact to this information whereas other investor may think of some other news as more substantial news. But, they fail to explain behaviour phenomenon of investors in their research paper and they are also of the view that their findings are not ultimate and there may be other factors that can explain the results of their findings. Bulkley and Nawosah (2005) examine whether short term momentum phenomenon can be explained by cross section dispersion of stock returns or not? Conrad and Kaul (1998) explain that expected returns vary greatly across stocks. Conrad and Kaul (1998) argue that stocks that are expecting high returns both during the formation period and holding period will outperform the market. Evidence of above argument is given by Lo and MacKinley (1990) but it is further elaborated by Jegadeesh and Titman (1993) and extended by Conrad and Kaul (1998). Fama and French (1996) and Grundy and Martin (2001) inspect this argument using the three factor model developed by Fama and French but interestingly they find the presence of momentum even after exerting control on expected return. Jegadeesh and Titman (2001) rejected the approach of usage of model in determining expected return but they take an assumption that returns are different across different stocks, they keep on varying and determined rationally. But, there is one similarity between returns from standard asset pricing model and returns from short-term momentum effect i.e. returns from both sources do not possess the quality of time variation. These returns are random and different for different stocks. Grundy and Martin (2001) argue that three factor model cannot explain momentum. Bulkley and Nawosah (2005) take the sample from three stock exchanges of 5 United States i.e. NYSE, AMEX and NASDAQ. Their sample period consists of January 1962 to December They also include the stocks that became de-listed during the long span of time. They adopt a methodology that is adopted by Jegadeesh and Titman (2001). They find that their results are in line with the results reported in the available literature i.e. holding period of 3 to 12 months result in abnormal returns. They reach to a finding that when no control is imposed on returns, the momentum strategy tends to exhibit similar results as exhibited in the paper by Jegadeesh and Titman (2001). But, momentum goes away when control for cross section dispersion is imposed by assuming that expected return of each stock is the average return in the sample period. But, this average return must be determined with great care and caution. Finally the conclude that cross section dispersion of expected return can explain momentum as this indication is already given by Lo and MacKinley (1990), Jegadeesh and Titman (1993) and Conrad and Kaul (1998). However, the financial volatility is increasing around the world, where countries such as Greece, Spain and Ireland are all jeopardous markets for businesses to enter as per Barth, Li and Prabgavivadhana (2011). The financial volatility is resulting in fluctuating currencies, which make transactions between countries a vital phase. The risk of being a multinational corporation is growing and hedging becomes increasingly fundamental for border-crossing organizations as described by Polak, Robertson and Lind (2011). Chan, Jegadeesh, and Lakonishok (1996) further argue that momentum strategy; either based on past returns or earnings surprises, exploit under reaction of investors in stock markets. They collect the sample from NYSE, AMEX and NASDAQ stock markets. The time period of research starts from January 1977 and ends on January They rank stocks according to either past returns or earning news basis. This paper has successfully explained the two living puzzles i.e. stocks historical returns and current earnings surprise. They also find that earnings momentum strategies result in lesser profits than price momentum strategies. They also find that stocks yield high momentum returns in first year but returns become average in second and third year. This finding presents a challenge to notion that momentum strategy yields higher returns with lower risk. They conclude that investors do not react to information quickly but they gradually respond to new information and prices adjust gradually, as analysts show laziness in adjusting their earnings forecast, this thing of analysts make market participants more sluggish which causes more delayed response. Most studies have been done on US stock markets in the field of momentum phenomenon. A few but useful studies have been done on stock markets outside United States. Like Rouwenhorst (1998) does a study of momentum on eleven stock markets and find that short term momentum effect is present in eight European stock markets. Schiereck, De Bondt and Weber (1999) examine the stock market of Germany and confirm the presence of momentum in that stock market. Liu, Strong and Xu (1999) study the stock market of United Kingdom for momentum purposes and find the evidence of momentum in that market. Chui, Titman and Wei (2000) and Hameed and Yuanto (2001) study the presence of momentum strategies in the
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