The study about the relevancy of Efficient Market Hypothesis (EMH) model in some countries in Gulf area is relatively new. Many researchers addressed this topic, but mostly concentrated in the UK and the US and are very rare in the Middle East.
The subject of efficient market hypothesis is more deliberated and discussed in available studies, but there is no special focus on the EMH form existing in Gulf area, by these means, this study analyses and evaluates the applicability of this model in some selected countries in Gulf area and how it would affect the decisions regarding the financial issues.
This chapter proposes the outlines of how the subject is going to be investigated and gives an introductory overview about the topic that is being probed.
At first, the motive of the study is declared and the framework is outlined, so as for the need and purpose of the study; then the research questions are proposed and stated. This section also contains a brief description about the participants which the study comprises. Secondly, the outcomes of the initial review of literature are appointed to form a base for the research questions. Thirdly, the rationalization for the used research approaches is stated, and then the methodology is justified and supported by evidential test that provides validation for the chosen methods.
This section also determines the suggested scheme for chapters 2, 3, 4, and 5. And in the final section, the outcomes of this study will be displayed, and the benefits will be discusses in details for each beneficiary.
Subject and Objectives
The primary objective of this study is to examine the form of EMH is available in the selected markets which would contribute in guiding these firms in implementing good corporate practices and making these reforms feasible and appropriate, and to identify to what extent EMH constitutes a good approach for financial practices in KSA, UAE, and Kuwait.
While this dissertation aims to study which form of EMH does the selected markets undertake, it doesn't take the burden to prove the accuracy of EMH. After determining which forms of EMH, the benefits to both the investors and corporations interested in the selected markets are huge. It enables the investors to examine if possibility of abnormal earnings exists, while enabling the management to choose wisely its accounting choices, financial choices, and timing decision.
The data for this dissertation is highly accessible. It can be easily retrieved from stock indexes of the selected countries. The dissertation aims to examine stock prices changes covering the last 5 years with data retrieved from Tadawul, ADX, Central Bank, and KSE. This data will then be compared with major economic and company specific events. These events can be retrieved from company's announcement, country's economic reports, newspapers, and specialized financial reports.
Specific research questions include:
What types of information are available in the selected markets? Are they only historical, publicly available, or private/public information?
To what extent the stock prices in the selected markets reflect the available information?
Which forms of EMH do these markets exhibit?
What are the implications for corporate finance associated with these forms which these markets demonstrate (accounting choices, financial choices, and timing decisions)?
Answering research questions provided a general guideline for these groups. In an efficient market, there possibility of abnormal earnings is very minimal, and management can't time their decisions in a manner that affect price stocks greatly. This is the contrast of weak form of EMH, where the possibility of abnormal earnings is high, and management can influence stock prices by timing their decisions.
Methodology
The sample covered 30 listed banks and financial service providers; 10 banks in KSA, 7 banks in UAE, and 13 banks in Kuwait.
Collection of data covering a time span of 5 years went through two major phases. The first included changes in stock prices of the selected sample. The second include factors that might affect stock price and are classified in three general categories. The first category will contrast the changes to country specific conditions such as economic changes, political/legal changes, and degree of relation to international markets. The second category contrast the changes in stock prices with company specific conditions such as management financial announcements regarding dividends and profit/loss, and decision making announcements such as retirement or firing of major key players inside the firms (Chairman, CEO). Some other variables are considered such as shocks to reputation and effect of competitors announcements.
Moreover, the impact of other factors has been investigated such as the laws set by the markets, then the country variables that constituted of inflation, interest and exchange rates. In addition, the data gathered included the time span between the factor occurrence and change in price.
The data is then run using SPSS software, which the researcher is very familiar with. Multiple regression analysis is then used to enable the author to examine if a relation exists between the change in stock price and the selected factors, which are the country variables (Inflation, Interest, and exchange rates).
The results of the statistical analysis will then be used to prove or reject the alternative hypothesis (ses). If a relation is established between the factors, it will imply that EMH holds in the selected markets. The time intervals between the factors occurrence and the change in stock price will then indicate how efficient the markets are
The statistical analysis included Descriptive Statistics, which include tables, graphs, numbers, and charts, they are used to explain, arrange, sum up, and present raw data, and then multiple regression analysis is performed to determine the most influential factors in the results.
Outline For Following Chapters
Chapter 2 summarizes relevant literature about the investigated topic. This chapter provides readers with a background about a topic and highlights on the significance of the study which helps in determining the similarities and differences.
General information on EMH is included in the literature review but the focus throughout will be on establishing the characteristics of different forms of EMH, as identified by studies that have been conducted locally and internationally. Literature Review provided readers with the needed knowledge and information about EMH, the review is based on reliable resources and academic researches.
Chapter 3 illustrates the quantitative approach findings; it includes the statistical analysis that is performed to identify the results of the survey that consisted of the questionnaires. It represents the study's findings and the statistical analysis results. This analysis provided the researcher with the data that is interpreted and prepared to evaluate the suggested hypotheses.
Chapter 5 is the discussions of the results; it reviews the theoretical hypotheses, and evaluates the compatibility of these hypotheses to the selected countries context. The findings of the analysis are used to evaluate the certainty or the rejection of the suggested hypotheses. Conclusions are made based on analysis which helped in formulating the general concept about the EMH model and how effective it is in the selected markets. The analysis of the hypotheses helped in identifying the research questions that are the researcher main concern.
Outcomes
The proposed research will have benefits for these principle beneficiaries, namely the author or researcher, the academic community, Professional Associations, Trainers and Developers, Managers and Organizations, and Policy Makers and Regulators:
The author or researcher: As an educator, the study will help in developing better comprehensive ideas about efficient market hypothesis, and to what extent it is needed, and how EMH is affected by different variables and factors.
The Academic Community: The research will add to the poor studies and researches base about EMH in KSA, UAE, and Kuwait markets and will also add to the available literature. The research could also work as a reference to future researches about this subject or any of its elements.
Professional Associations, Trainers and Developers: There is a scarcity of research concerning the effects of many factors on EMH and what type of EMH exists in the selected countries. Therefore, this study will be valuable to educationists, course administrators, and other researchers who work on related fields.
Managers and Organizations: Create awareness about the important of identifying the form of EMH that their markets endorse, eventually, the results of this study might make corporate decision-makers become more aware of the use of EMH as a financial tool.
Policy Makers and Regulators: The research will guide them about the context concerning the prospects that may encounter in case EMH tool is applied in the selected countries.
REVIEW OF THE LITERATURE
This chapter aims to give a general review of the literature on the effect of EMH on the financial markets more specifically on banks. This section includes a theoretical background of EMH, it explores it by including its definitions and essential elements, and it also provides some reviews of literature conducted on the investigated subject.
Introduction
According to Fama (1970), a market is efficient when the price fully reflects the information set, thus, if the price would be unaffected by revealing the information to all market participants. The efficient market hypothesis, EMH, states that financial markets are efficient. Stressing on the term "fully" implies that no real market could ever be efficient, and it is somehow indicating that the EMH is almost certainly false.
Since 1970, EMH has been one of the most notorious and extensively studied propositions in all the social sciences (Smith and Ryoo, 2003). EMH created considerably important controversy through the application of many theoretical models and empirical studies of financial securities prices (Lo, 2007).
Economists still have no consensus about EMH despite all the theoretical and empirical studies that were conducted to support or attack the EMH. Moreover, even with the progress in the statistical analysis, databases, and theoretical models surrounding the EMH, the final outcome and findings of all of these studies only served to make the determination about EMH harder on each side of the debate, the defenders and the attackers of EMH (Lo, 2007).
Definition
Efficient Market Hypothesis is when the prices are affected by information that is unknowable in the present and appears randomly in the future. EMH indicates that by using any information that the market already knows, it is impossible to constantly outperform the market, except by luck (Fama and French, 1992).
Fama was the first to introduce the term efficient market into the literature in 1965, then this definition was followed by many definitions, the following quote illustrate one of these definitions: 'An "efficient" market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants.' (Fama, 1965)
History
In the early 1960s, Professor Eugene Fama developed the term "Efficient market hypothesis" (EMH) through a study that was conducted for this Ph.D. thesis. Chronological reviews and researches related to EMH started since the 16th century, table 2.1 resumes the evolving of EMH in the literature from year 1565 until year 1997, showing different outcomes and findings and conclusions made by these researchers throughout different period of time, which formulated the EMH concept. We can notice that most of the reviewed researches support market efficiency, and we also observe that attacking EMH mostly occured in 1980s and 1990s.
Since the first introduction of "efficient market" term, there have been many empirical researches that contributed in the evolution and formulation of the efficient market hypothesis, as it was tested in different situations and circumstances using different variables, and implying different outcomes, which created some controversial debates and arguments which either supported or rejected the validity of the hypotheses. The following, will show how EMH evolved through literature (Sewell, 2011):
In 1965, the term efficient market was defined by Fama for the first time, while in the same year the first formal economic argument for efficient markets was given by Samuelson. In the following two years, the term "efficient markets hypothesis" was determined by Harry Roberts who differentiated between weak and strong form, becaming the classic classification in Fama (1970).
In 1970 Eugene F. Fama's gives his definition for the efficient market hypothesis, saying that market is efficient if prices always fully reflect available information.
in 1980, LeRoy and Porter's research demonstrated excess volatility resulting the rejection of market efficiency. Werner F. M. DeBondt and Richard Thaler, in 1985, formulated the start of behavioral finance, discovering that stock prices overreact and evidencing substantial weak form market inefficiencies.
In 1990, Laffont and Maskin proved that imperfect competition may cause failure of EMH. In this year, Lehmann rejected the efficient markets hypothesis.
In 1994, Metcalf and Malkiel argued that experts' selection of the portfolios of stocks do not constantly beat the market.
Forms of EMH:
There are three common forms of EMH, which are: weak form efficiency, semi-strong-form efficiency, and strong-form efficiency, and each one of them has different propositions for how markets work.
Weak-Form Efficiency
Weak-form EMH infers that there no need to look at past stock prices that don't help to predict future prices. Most academic studies have a tendency to consider that weak-form EMH is rather well held (Pistor, 2003).
As in this form, the price reflects all information contained in market trading data (past prices, volume, dividends, interest rates, etc.). Therefore, an investor is not able to employ past prices to recognize mispriced securities (Pistor, 2003).
Weak form technical analysis refers identifying future patterns in prices by using past patterns in stock prices and trades.
Weak form states that the market cannot be beaten by knowing past prices. Its features are (Hagin, 1979):
Excess returns cannot be produced through performing investments that are supported by historical share prices or other financial data.
Weak-form efficient market is theoretical in nature, where current share prices are considered as the best unbiased estimate of the security's value. Analysis in weak form efficiency can be used to identify if the stocks are undervalued or overvalued. That's why some investors who intend to seek profitable companies can research financial statements to earn profits.
Semi-Strong Form Efficiency
The semi strong form efficiency is the most controversial one; proposing that it is not possible to always beat the market using publicly available information (Pistor, 2003).
Most distinctive features are:
Share prices change to publicly available new information, within a small but limited amount of time, with an unbiased manner so trading on that information yield no excess returns. Therefore Semi Strong EMH infers that analysis techniques won't be able to produce excess returns.
To examine semi-strong form efficiency, the change due to earlier unknown information should be of a rational size and instant. In order to achieve that, test should be performed through constant upward or downward adjustments after the initial change must be looked for. If such adjustments exist it is suggested that investors had analyzed the information in a biased way thus inefficiently.
Semi-strong EMH served and stood up logically well. The basic analysis to select stocks includes doing assessment using announcements, financial statements, and other publicly available information about firms (Pistor, 2003).
Strong-form Efficiency
The strong form efficiency states that everything that is known, even unpublished information has already been reflected in present prices. The implication would be in that case that there is no gain even if trading was based on some inside information (Pistor, 2003).
Strong form of EMH infers that any kind of information cannot be used to beat the market. It is evidential that this form does not hold. Features of this form are (Hagin, 1979):
Prices reflect all information and excess returns cannot be earned.
Strong-form efficiency is impossible where there are legal barriers to private information to become public. Studies on the U.S. stock market showed that trading is on inside information.
Examining if the market is strongly efficient, a market needs to exist where investors cannot constantly earn excess returns for a long period of time.
All private information is reflected in a Strong-Form EMH, there are two types of private information (Pistor, 2003):
a. Inside information: which is internal information recognized by company management but did not yet become public.
b. Private review: which is relied on public information such as a report based on public accounting statements.
Arguments:
Fama (1970) pioneered the Efficient Market Hypothesis (EMH) by stating that the markets are as efficient as the quantity and quality of information revealed by corporations. He categorized the markets into three forms depending on whether prices fully reflect, at any time, the available information (Fama, 1970, p. 414). The strong form, while only theoretical, suggests that all information is available for investors, thus eliminating the possibility of abnormal earnings. The semi-strong form proposes that all publicly available information is reflected by prices, whereas the weak form indicates that only historical information is reflected in the price.
Nowadays, no market is isolated from another. Investors, while acknowledging the risks associated with foreign trade, seek cross-border investments to increase their profits, especially if such investments may result in abnormal earnings.
However, international investors must understand the behavior of these markets before diversifying their portfolios into intentional ones (TaÅŸ and TokmakçioÄŸlu, 2010). Similarly, firms operating in such markets can judge the fairness of their securities value based on the market form (Ross, Westerfield, and Jaffe, 2010).
Ross et al (2010) also suggest that market efficiency will impact accounting choices, financial choices, and the timing decisions in the world of corporate finance. In addition, policy makers can benefit greatly from identifying the efficiency of markets, enabling them to better remodel legislations that can attract capital.
Very few researchers have examined EMH in emerging markets (For example Kawakatsu and Morey, 1999, Chaudhuri and Wu, 2003, Chaudhuri and Wu, 2004).Yet the literature on EMH is enormous, containing both supportive and contradictive findings.
Some observers dispute the notion that markets behave consistently with the efficient market hypothesis, especially in its stronger forms. Some economists, mathematicians and market practitioners cannot believe that man-made markets are strong-form efficient when there are reasons for inefficiency including the slow diffusion of information, the relatively great power of some market participants (e.g. financial institutions), and the existence of apparently sophisticated professional investors. The way that markets react to surprising news is perhaps the most visible flaw in the efficient market hypothesis. For example, news events such as surprise interest rate changes from central banks are not instantaneously taken account of in stock prices, but rather cause sustained movement of prices over periods from hours to months (Hagin.1979).
EMH Skeptics dispute that there is few investors who have outperformed the market for a long period. These investors, including Peter Lynch, Warren Buffett, George Soros, and Bill Miller have strategies that were based on identifying markets where prices do not accurately reflect the available information, in opposition to the EMH (Malkiel, 1996).
EMH is generally rejected by the public since many believe that EMH states that a stock's price properly forecasts the fundamental company's future results, and due to the fact that stock prices do not reflect the future results of the company in many cases, therefore many people reject EMH for being obviousloy wrong (Fama, 1998).
However, EMH actually states that a stock's price stands for the aggregation of all future outcomes' probabilities for the company, relying on the best information available at that time, it is not something required in EMH whether the information turns out to be correct or precise, i.e., it is not required that a stock's price reflects a future performance of the company, but the most probable estimation of that performance that can be made with publicly available information (Fama, 1998).
Announcement Effect
Announcement effect is defined as the news' impact on markets; the news would be about a change that will occur at some future date. The term can be also explained as the reaction to any development that affects trading. It is more commonly used to describe investor's reactions to changes in monetary policy. Announcement Effect is also known as a "signal effect" (Bomfan, 2000).
A good example of announcement effect would be when stock traders excitedly wait for the changes announcement in Federal Reserve policy, and stock volumes are significantly higher on Fed days; and it is also noticed that trading on the day before announcements of Fed policy is somewhat calm (Bomfan, 2000).
Whereas bank announcement is an announcement made by the bank, usually after their first meeting of the month and it is dedicated to monetary policy. Bank announcements are considered to be significantly important since because most banks do not publish the minutes of their meetings, therefore, the outcome of the announcement will affect the stock and bond markets; an outcome could be a change in interest rates, where higher or lower interest rates are bearish or bullish for stock markets and bullish or bearish for bond markets (Bomfan, 2000).
Overview About Financial Markets In Kuwait, KSA, & UAE
Kuwait
The Kuwait Stock Exchange (KSE) was established in 1977. It is one of the indicators of the booming economy of Kuwait. It has a significant influence in Gulf region and the Middle East. The money and capital markets and other derived sectors are considerably developed in Kuwait (CBK, 2012).
The Foreign Investment Law imposed in 2000 allowed the foreign investments in the Kuwait Stock Exchange. It is actually one of the biggest stock exchanges in the Gulf area (CBK, 2012).
The Central Bank of Kuwait, established in 1969, is vitally facilitating the monetary transactions of Kuwait financial market. It plays an imp0ortant role in stabilizing the financial environment in the country, acting as the chief financial adviser of the government. It is also the chief regulatory authority of the banks and other financial institutions of the country. All these facts help in keeping a guard on the Kuwait financial market (CBK, 2012).
United Arab Emirates (UAE)
The Dubai Financial Market was founded in 2000, it is located in Dubai; it is one of three stock exchanges in the UAE. DFM comprises 61 companies listed on, where most of them are UAE-based companies and a few dual listings for companies based in other MENA region countries. Foreign companies are from the following countries: Bahrain, Oman, Kuwait, and Sudan.
During 2004 and 2005, the volume of shares traded and the many companies' share prices significantly increased. At the end of 2005 and the 2006 first few months, share values dropped by around 60% on DFM (Squalli, 2005).
Abu Dhabi Securities Exchange (ADX) lists mostly UAE companies; NASDAQ Dubai function was to trade international stocks (Squalli, 2005). The Securities and Commodities Authority (SCA) regulate and governe DFM and ADX. While, Dubai Financial Services Authority (DFSA) govern NASDAQ Dubai, DSFA is equivalent to the Securities and Exchange Commission in the U.S. Unlike DFM and ADX, NASDAQ Dubai is an electronic exchange with no trading floor that is located in Dubai International Financial Centre (DIFC) (Squalli, 2005).
Saudi Arabia (KSA)
Like the U.A.E., Saudi Arabia is characterized by a great level of bank efficiency, profitability, and stability, but it is relatively small compared to Saudi Arabia's GDP (Ingves and Khan, 2004).
The equity market in KSA has significant turnover and considered as the largest market capitalization among Arab stock exchanges; in the other hand, there is limited frugality of investment information (Ingves and Khan, 2004).
Three factors Bank mold portfolios in Saudi Arabia:
Low-cost demand deposits fund Assets to a large extent, where healthy profitability is largely determined by lending rates.
It is difficult for banks to diversify risks locally due to the economy dependence on oil, particularly credit risk, demanding high levels of capital.
Conservatism is still ensured by provisions which prescribe prudential credit limits, including related parties, the ratios of liquid assets (Ingves and Khan, 2004).
Overview of Research Methodology
The sample covered listed banks in Kuwait, KSA, and UAE. Collection of data covering a time span of 5 years will go through two major phases. The first will include changes in stock prices of the selected sample.
The second include factors that might affect stock price and are classified in three general categories. The first category will contrast the changes to country specific conditions such as economic changes, political/legal changes, and degree of relation to international markets.
The second category contrast the changes in stock prices with company specific conditions such as management financial announcements regarding dividends and profit/loss, and decision making announcements such as retirement or firing of major key players inside the firms (Chairman, CEO).
Some other variables will be considered such as shocks to reputation and effect of competitors' announcements. Hypothesis will mainly focus on using a null hypothesis and alternative hypothesis (hypotheses).
The results of the statistical analysis will then be used to prove or reject the alternative hypothesis(ses). If a relation is established between the factors, it will imply that EMH holds in the selected markets. The time intervals between the factors occurrence and the change in stock price will then indicate how efficient the markets are.
Conclusion
Believing or not that the markets are efficient, the efficient market hypothesis is a proper indicator to start with when considering asset price formation. It serves as a framework for trying to understand the movements in stock prices and probably, it is the single most important paradigm in finance, it helps in understanding and formulating a basis for various investment strategies and also explain why prices move the way they do.
As been shown through reviewing literature, facts support weak and semi-strong forms of EMH but not the strong form.
On the bottom line, EMH is a concept and a model whereby could be as functional in many ways but could also be wrong in some respects. In fact, the financial crisis in 2007 helped in shaking the assumption that EMH is safe. Despite that EMH is not perfectly perceived, still there is no alternative theory to EMH that has yet appeared (Krause, 2010).
