The Efficient of the UK and Saudi Stock Market - Case Study Example

To What Extent the UK Stock Market (FTSE 100) Is More Efficient Than the Saudi Stock Market Contents Contents 2 Introduction 3 Brief Overview of UK Stock Market (FTSE100) 3 Brief Overview of Saudi Stock Market 4 Concept of Market Efficiency 4 Market Efficiency of UK Stock Market 6 Market Efficiency of Saudi Stock Market 6 Comparison of UK Stock Market (FTSE 100) and Saudi Stock Market 7 Information Availability 7 Use of Historical Price 7 Regulations 7 Insider Trading 8 Conclusion 8 Reference 10 Introduction Almost every country has its own stock market where the stocks of the domicile companies are listed. Stock markets are generally categorized as per their efficiency level. It is generally seen that the market index of the share market exchange reacts differently when any new information regarding the stocks is made available to the investors. It can also be seen that the share prices change in absence of new information. In many stock markets the investors follow the trends of the share price movements in order to predict the future stock prices and take advantage of the share markets. These situations reflect the extent of the market efficiency of the stock markets. In this project the UK stock market’s efficiency has been compared to that of the Saudi stock market. The UK stock market with the index FTSE 100 has been studied from the point of view of market efficiency. The market efficiency of Saudi stock market has also been studied carefully. The theoretical aspects of the efficient market hypothesis have been discussed in order to understand the market efficiency in a better way. The comparison of the UK stock market with Saudi stock market has been made on the basis of the information available to the investors about the stocks, use of historical price for predicting the future stock price, stock market regulations and insider trading. Brief Overview of UK Stock Market (FTSE100) The companies in UK are listed in the London Stock Exchange. The London stock exchange is one of the oldest stock exchanges, which is more than three century old. The stock exchange began its trading in 1698. The regulated London stock exchange was formed in 1801. Electronic trading in this stock exchange began in the year 1997(London Stock Exchange, 2011). Financial times and London stock exchange jointly own the FTSE Company which has various indexes. The FTSE 100 contains the stocks of top hundred blue ship companies which are listed in London Stock Exchange like ARM Holdings, Aviva, Barclays, Essar Energy, and GKN etc. This index comprises of almost eighty one percent of the total capitalization of UK stock market. The index shows the performance of these high capitalized companies (FTSE, 2010). Brief Overview of Saudi Stock Market The first joint stock company, Arab Automobile was established in Saudi Arabia in 1930s. After that many public companies started establishing in Saudi Arabia. Many large corporations also started establishing in Saudi Arabia but there was no formal market where the shares can be traded. In 1984, the Saudi Arabian Monetary Agency was formed by the government to regulate the market. In 2003, Capital Market Authority was formed to supervise and regulate the capital market. The stocks of Saudi capital market are traded in Tadawul, which is the stock exchange of Saudi Arabia (Tadawul, 2011). Tadawul was formed in 2007 and at present more than one hundred and forty companies are listed in Tadawul. Equity, bonds, sukuks, mutual funds and ETFs are traded in this stock exchange. Concept of Market Efficiency The concept of market efficiency evolved from the efficient market hypothesis (EMH). This theory was given by Eugen Fama in 1960’s. According to this theory, the stock prices should reflect all the important and relevant information. In other words, the stock price should be unbiased. Since the share prices will be unbiased, a trader will not be able to make profit from the share market operations continuously for a long period of time. The efficient market hypothesis relates the stock prices with the actions of the traders. As per this theory stock markets’ efficiency can be classified into three categories that is, the weak form of market efficiency, semi-strong form of market efficiency and strong form of market efficiency. In weak form of market efficiency the stock price reflects the past performance of the stock. The future price of the stock cannot be predicted from the historical data. Therefore, the technical analysis will not be fruitful in reaping profit from the stock markets. The most common tests which are made to validate the existence of weak form of market efficiency are spectral analysis, filter technique etc (Harder, 2010, p.8). In semi strong form of market efficiency the price of the stock reflects all the publicly available information. In this type of market, insider trading is prevalent. Hence, in this type of efficient market not only technical analysis but also fundamental analysis cannot be held effective to beat the stock market. Individuals who have the access to insider’s information can only beat the stock market every time. The tests which are performed to validate the presence of this type of efficiency are made on the basis of abnormal returns (Harder, 2010, p.9). In strong form of market efficiency the stock prices reflect all the relevant information. In this type of efficient market an individual who have insider’s information cannot beat the stock market every time as the stock prices reflect all the information which is relevant for trading. This type of market efficiency can be judged by evaluating insider trading (Harder, 2010, p.9). Hence, it can be said that the efficient market is the one where the market price of the stock is unbiased (Leonard N. Stern School of Business, 2011). The important points which are generally considered for checking the efficiency of stock markets are whether the price of stock reflects all the available and relevant information required by the investors; whether any prediction can be made with the help of the stock’s past performance; whether insider trading is prevalent in the stock market and whether any investor can continuously take advantage of the stock market and earn profit for a long period of time. Market Efficiency of UK Stock Market As discussed earlier in the previous section, for judging the efficiency of the stock market, it is important to check whether the market players can earn profits for a long period of time. In efficient markets no market player can earn profit continuously because the stock prices are perfect and reflect all the available information. In a study conducted to check whether the mutual funds performed persistently in UK, it was found that no fund in the mutual fund sector could sustain its high performance for a long period of time. This signifies that the UK market is efficient. Another finding of this study was that the fund managers were not able to use the historical data to earn profit. This proves that the technical analysis was of little use for predicting the future price of the stock. It was also found that every investor of the mutual fund earned profit at some or the other time if not continuously (Blake and Timmermann, 2003, p.42). In this regard another study was made to check how the announcement of merger and acquisition affected the UK stock market. In this study it was found that after the announcement was made, the market witnessed abnormal return for a long period of time. This indicates that some inside information was leaked and it was used by the bidders. This proves that the UK market may not have the strong form of market efficiency but at semi-strong form it is efficient (Vago, 1998). Market Efficiency of Saudi Stock Market Many studies have been made on the market efficiency of Saudi stock market. In one of the study which was conducted to test the efficiency of the stock market of Saudi Arabia, it was found that the stock prices in the Saudi stock market were not independent. If the stock prices are not independent then it can be said that the price movements can be predicted by analyzing the historical performance of the stock. It has been already discussed in the previous section that for judging the stock market efficiency it is important to assess the use of historical data in predicting future stock price movements because in efficient markets historical data cannot be used to predict the future price. Hence, it can be said that the Saudi stock market is not efficient (Onour, 2010, p.11). Comparison of UK Stock Market (FTSE 100) and Saudi Stock Market In the earlier sections the efficiency of both the markets has been discussed. As per the discussion a comparison has been made between the UK stock market and Saudi stock market. Information Availability As discussed earlier, in the UK stock market the stock price reflects almost all the publicly available information and to an extent many relevant information are also reflected in the stock price. In Saudi stock markets there is a dearth of adequate information that is made available to the investors. Use of Historical Price In UK stock market historical price of the stock cannot be used to predict the future price of the stock. Analysis of the past performance cannot be utilized to beat the stock market. In contrast to it, in the Saudi stock market the prices of the stocks are not independent or random and historical price can be used to predict the future price. Regulations The Financial Service Authority is the regulator of UK’s financial services (Financial Services Authority, 2011). It lays down various rules and regulations regarding the operations in the stock market. There are strict regulations in UK stock markets. Saudi stock market is regulated by the Capital Market Authority. Insider Trading In UK stock market, insider trading has been banned by the market regulators. There are instances where one can find the possibility of insider trading as discussed in the previous sections but in general, insider trading is not very prevalent. As the Saudi market is not as efficient as the UK stock therefore, there is every possibility of insider trading to be very common in Saudi stock market. Conclusion After analyzing the various aspects of the Saudi stock market and UK stock market and comparing them with the features of the efficient market, it can be said that the UK market is more efficient than the Saudi stock market in many ways. To come to this conclusion many research papers which are related to the market efficiency of these two markets have been studied. On the basis of these studies it can be concluded that the UK stock market is far more efficient than the Saudi stock market in three ways, firstly the stock prices of the Saudi stock market are not independent and can be used to predict future stock price where as the stock prices of the UK stock market cannot be predicted using the historical prices. Secondly, insider trading is more prevalent in the Saudi stock market compared to the UK stock market. Thirdly, the stock prices of UK stock exchange reflect almost all the relevant information which cannot be said for the Saudi stock market. More information is available to the investors of the UK stock exchange than the investors of Saudi stock market. Reference Blake, D. and Timmermann, A. (2003). Performance Persistence in Mutual funds. [Pdf]. Available at: http://www.fsa.gov.uk/pubs/other/pastperf_mutalfunds.pdf. [Accessed on: August 11, 2011]. Financial Services Authority. (2011). About us. [Online]. Available at: http://www.fsa.gov.uk/Pages/About/What/index.shtml. [Accessed on: August 14, 2011]. FTSE. (2010). FTSE 100. [Online]. Available at: http://www.ftse.com/Indices/UK_Indices/index.jsp. [Accessed on: August 11, 2011]. Harder, S. (2010). The Efficient Market Hypothesis and Its Application to Stock Markets. Germany: GRIN Verlag. Leonard N. Stern School of Business. (2011). Market Efficiency - Definition and Tests. [Online]. Available at: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/invemgmt/effdefn.htm. [Accessed on: August 14, 2011]. London Stock Exchange. Our History. [Online]. Available at: http://www.londonstockexchange.com/about-the-exchange/company-overview/our-history/our-history.htm. [Accessed on: August 11, 2011]. Onour, I. A. (2010). Testing Efficiency Performance of Saudi Stock Market. [Pdf]. Available at: http://www.kau.edu.sa/Files/320/Researches/54589_24913.pdf. [Accessed on: August 11, 2011]. Tadawul (2011). About us. [Online]. Available at: http://www.tadawul.com.sa/wps/portal/!ut/p/c1/04_SB8K8xLLM9MSSzPy8xBz9CP0os3g_A-ewIE8TIwODYFMDA08Tn7AQZx93YwN3I_3g1Dz9gmxHRQB7GACB/. [Accessed on: August 11, 2011]. Vago, E. R. D. (1998). Efficient financial market. [Online]. Available at: http://html.rincondelvago.com/efficient-financial-market.html. [Accessed on: August 11, 2011]. Read More