CARESSWorking Paper #01-20
"Tests of Financial Markets' Efficiency for Thirteen
Small EuropeanCountries
By
Yochanan Shachmurove
UNIVERSITY of PENNS YL VANIA
Centerfor Analytic Research
in Economics and the Social Sciences
McNEIL BUILDING, 3718LOCUST WALK
PHILADELPHIA, PA 19104-6297
Tests of Financial Markets' Efficiency for Thirteen Small European Countries
YochananShachrnurove
Departmentsof Economics
The City Collegeof the City universityof New York, and
The University of Pennsylvania
July 200 I
Pleasesendall correspondence
to ProfessorYochananShachmurove,
Departmentof Economics,
Universityof Pennsylvania,3718LocustWalk, Philadelphia,PA 19104-6297.Fax: 215-573-2057.
Telephone numbers:
215-898-1090 (0),
yochanan@econ.sas.upenn.edu
610-645-9235 (H).
Electronic Mail:
Tests of Financial Markets' Efficiency for Thirteen Small European Countries
Abstract
This paperstudiesthe characteristicsof thirteen small Europeanstock markets,in order
to find internationalsupport for the presenceof efficiency in fmancial markets. The thirteen
boursesare locatedin Belgium, Denmark,Finland, Greece,Ireland, Luxembourg,Netherlands,
Norway, Portugal, Spain, Sweden,Switzerlandand Turkey. The paper tests the Overreaction
and UncertainInformation Hypothesesby examiningthe behaviorof thesemarketsover a 60day period following positive or negativemarket disruptions. The conclusionsare that for this
particulartime lag most small Europeanstockmarketsoperateunderefficient conditions.
Key Words:
Financial Market Efficiency; Europe; Overreaction and Uncertain Infonnation
Hypotheses; Belgium,
Denmark, Finland,
Greece, Ireland,
Luxembourg,
Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and Turkey; World
Stock Index.
JEL Classifications: C3, D8, F3, F4, GO, G 1, L8, 05, 052.
I would like to thank Richard Ajayi, Albert Ando, Peter Chow, Francis Diebold, Bill Ethier,
Stanley Friedlander, Malcolm Galatin, Bill
Greenwald, Alan Heston, Mitchell
Kellman,
Lawrence Klein, Ahrnet Kocagil, Roberto Mariano, Seyed Mehdian, Suleyman Ozmucur, Emanual
Shachmurove,and seminar participates of the Penn. International Economics Brown Bag Lunch for
useful discussions and advice. I would like to thank the excellent research assistanceby Luca
Mangini, Timothy Kojo Minta, Zhi Li, Paul Staples, Neel Shah, and Yana Stunis. A partial
financial support from the Schweger Fund of The City College of The City University of New
York and the hospitality of the Center for Analytic Research in Economics and the Social
Sciencesof the University of Pennsylvania are gratefully appreciated.
1"
Tests of Financial Markets' Efficiency for Thirteen Small European Countries
I.
Introduction
Financial agents interact with each other in a rational and efficient manner. A
competitiveenvironment,suchas the one governingfinancial markets,fostersefficiency. New
information is constantly being absorbedby investorsand reflected in security returns. The
instantaneousprocessingof data meansthat future rates of return cannot be predictedby past
returns. Thesepostulationshavebeencodified underthe Efficient Market Hypothesis(EMH).
This paper studiesthe characteristicsof thirteen small Europeanstock markets,in order
to find internationalsupport for the presenceof efficiency in financial markets. The thirteen
boursesare locatedin Belgium, Denmark,Finland, Greece,Ireland, Luxembourg,Netherlands,
Norway, Portugal,Spain,Sweden,Switzerlandand Turkey.
Attempts to consistentlyencounterthe Efficient Market Hypothesishave failed. Faced
with the arrival of unexpectedinformation, agents do not adjust prices immediately in
accordancewith the news. The implications of new information on financial derivatives are
often exaggeratedandtherefore,time for adjustmentis requiredto equatethe price level with the
meanrateof return.
The OverreactionHypothesis(OH) explainstheseinefficienciesby predictingthat prices
will be undervaluedprecedingunfavorableannouncements.As Figure 1 indicates,favorable
disclosuresare foreseento enticethe marketto establishequity prices abovethe averagerate of
return.
2
FIGURE 1.
Favorable
Stock
Price
Changes
as Postulated
Events
by EMH, OH and UIH
Events
Unfavorable
EFFICIENT
MARKET HYPOTHESIS
~
$~Q~~ Prlp:e:'
~r
~,~
f!:
P
p
,...1
+
:~
time
k
~1
k
:/i
V
time
OVERREACTION HYPOTHESIS
Stock Price
CC
p
p
time
UNCERTAIN
INFORMATION
-1
Q
J$
k
time
HYPOTHESIS
;
Stock Pr!;};ce
c
-;
~
p~
-1
t
pe
po
pu
= 0 represents
= equilibrium
= overreaction
=
uncertain
k
the event
price
price
information
time
day
price
1.::,iJiI
k
time
3
Yet, the efficiency assumptionretains its merit. In the face of abnormal returns and
profiteering, the premise of efficiency is altered. Investorsreact to the arrival of unexpected
information and the associateduncertaintyrationally, by undervaluingthe prices of securities.
Therefore, the prediction in the event of negative announcementscoincides with the one
proposedby the OverreactionHypothesis.
The Uncertain Information Hypothesis(UIH) modelsthis rational behaviorof agentsin
an uncertainenvironment. The theory predictsthat return volatilities will increasefollowing an
announcement. Specifically, post-negativedisclosure volatilities are greater than positive
volatilities. The latter is a rational consequenceof risk-averseagentsattemptingto err on the
sideof caution.
Although there has been intense scrutiny of American institutions and, foreign Asian
markets, smaller stock markets have often been ignored.! This is especially pertinent to
secondaryEuropeanmarkets. Their diminutive size, in terms of both the numberof securities
listed and investors, implies a lack of efficiency and could explain the absenceof interest.
However,two factorsmight negatetheir disadvantage:the existenceof the EuropeanUnion (EU)
and the increasingtrend of financial globalization.
European Union regulations and monitoring have reformed many of these bourses,
improving their operationalefficiency and increasingtheir importancein the domesticfinancial
sector. Among the countriesstudied,only Norway, Switzerlandand Turkey are not membersof
the EU.
Globalizationhasencourageddomesticand foreign investorsto diversify their portfolios
across national borders. Legislation fostering foreign ownership and portfolio investment
enactedin the 1980sand 1990shaspermittedthe exchangessurveyedto benefit from this trend.
4
Their proximity and dependenceon the larger regional (London, Frankfurt, Paris, Milan) and
North American (New York, Toronto) financial markets has acceleratedthe trend towards
integration.
The study uses market indexes as a benchmarkin order to eliminate stock specific
anomaliesand to scrutinizethe operationof the entire market. The main purposeof the paperis
to verify the consistencyof the thirteen Europeanmarketswith either the Efficient Market,
Uncertain Information or OverreactionHypothesis. The examinationtracesthe effects of the
passageof time on stockreturnsfollowing favorableandunfavorablenews.
The benchmarkadaptedfor the purposeof generatingexcessreturns for the European
exchangesis the World Stock Index. The individual marketrate of return is then regressedon
the global rate of return to generateevents. The market indexesfor eachcountry are listed in
Table 1.
TABLEt
Namesof the Small European Stock Market Indexes
$
The remainderof the paper is organizedas follows. SectionII describesthe data and
methodology. SectionIII documentsthe empirical results. The study is concludedin Section
IV.
II.
Data and Methodology
The methodologyintroducedby Brown, Harlow and Tinic (1988) is followed to test the
validity of the three hypothesesover sixty days following an unexpecteddisruption in the
national, relative to the World Stock Index financial environment. The data are closing daily
stockmarketindexesfor thirteenEuropeansecuritymarkets.
Based on Blackwell Finance(1996) the exchangesselectedfor the study have unique
characteristics.Their relatively small size refers to the numberof companieslisted, securities
tradedand a low market capitalization. Comparedto their G7 counterparts.thesemarketshave
playedlesserroles in their domesticfmancial structure. Taxeson transactions,capital gainsand
profits have hamperedtheir development. However, Greece,the Netherlands,Spain, Sweden,
Switzerlandand Turkey do not subjectforeignersto capitalgainstax anymore.
In general,legislationpreventingforeign portfolio investmenthasbeenabolished,due to
the EuropeanUnion's and the Organizationof Economic Co-Operationand Development's
(OECD) policies. Notable exceptionsare Turkey and Norway, which are not membersof the
EuropeanUnion. Norway is not member of the OECD either. In the case of foreigners,
"income" duties are subject to revisions under the double taxation provisions of bilateral tax
treaties,meaningthat the majority of non-residentsaresubjectto a tax levy of about 15 percent.
6
Foreign investors receiving dividends from Finnish securities are liable to pay tax,
subject to discounts provided by bilateral treaties. Legislation repealed in 1993 placed
ownershiprestrictionson non-residents.
The Athens Stock Exchangehas been very thin and limited to a small equity market.
Despite the reforms introduced in the 1990s,the bourse still plays a minor role in Greek
corporatefinance. Restrictionson capital mobility were abolishedin 1994 althoughthe legal
framework intended to integrate the Greek market into the global financial network was
concludedonly in late 1995[OECD, 1995].
The Brusselsmarketis one of the most internationalof the exchangesstudied. More than
half of its listed shareshave foreign issuers. Belgium does,however,levy a withholding tax on
non-residents.
The foreign equities listed at the boursein Luxembourgoutnumberdomesticissuesby
four to one. As in other European countries, Luxembourg does not employ regulations
governingthe repatriationof profits. Ireland doesnot makeany distinctionsbetweenhome and
alien investors.
Switzerland constitutes along with Belgium, Luxembourg and Ireland a group of
countriesthat haveproceededfarthestwith plans for global marketintegration. Over half of the
companiesand a third of the securitieslisted on the Zurich exchangeare foreign owned. One
caveat:the Swiss dividend and investmentincometax rate standsat 35 percent,well abovethe
Europeannorm of25-28 percent.
Portugal is one of the countriesfalling behind its Europeanneighbors. Lisbon levies
taxes on a number of items associatedwith foreign portfolio investment,including duties on
transactions,investment income and capital gains. Furthermore,a system of government
regulationshampersforeign direct and portfolio investmentoriginating outside the European
Union. Spainimposesdividend and incometaxesthat are subjectto alterationbasedon bilateral
tax agreements.
Sweden is noted for offering a higher tax rate (30 percent) on dividends than the
customarylevy of other Europeancountries. The final taxation level is subject to bilateral
agreementsbetweenSwedenandthe countryof residenceof the foreign investor.
To summarize,the majority of the boursesare open to foreign investment,despitetheir
unflattering liquidity and size. The questionremainswhetherthis transparencyis sufficient to
produceefficient markets.
The calendarperiod and the total numberof daily observationsrecordedfor eachcountry
is presentedin Table 2. Morgan StanleyCapital InternationalPerspective,Geneva(MSCIP),
compiledthe indexes. Thesestock marketindexesare convertedinto daily ratesof return. The
indexescalculatedby MSCIP do not double-countthosestocksthat are multiple-listed on other
bourses. Hence, any correlation in market behavior cannot be attributed to multiple listings
[Shachmurove,1996]. The MSCIP datawasobtainedthroughDatastream.
8
TABLE 2
Time Period and Total Observations
All databeginat the earliestdaterecordedby Datastrearn.
The methodologyemployedto assessthe empirical evidencein supportof either one of
the three hypothesesis similar to the procedureintroducedby Brown, Harlow and Tinic (1988).
The focusis on the measuresof post-eventvolatility andthe cumulativeabnormalreturns.
The World Stock Index is employed as the benchmarkto generatethe positive and
negativeexcessreturns for the thirteen small Europeanmarkets. The rate of return of each
marketis regressedon the world rate of return, with the residualidentified as an "event" if it is
found to be greaterthan or equalto 2.5 percentin deviation. The exceptionis Turkey, in which
casethe adopteddeviationpercentageis ten percent,sincelower percentages
generatedtoo many
eventdays. Hence,t is by defmition an eventif,
IRil -
~I ~ 0.025
(Q
9
the return (Rt') of stock price index i (i = 1, ...,13) on day tis 2.5 percentlargerthan the mean
return for the particular index (Ri) over the sampletime frame. As such, the event day is
consideredDay 0 and the relevant observationsare obtainedby examining subsequentDay 1
throughDay 60. The variancesarecomputedasfollows:
1
Var = ~
M
L
(Rit-Rij)
-'\2
(..2 .)
Mt=l
-
where M denotesthe numberof post-eventdaysand R if representsthe averagereturn over M
days,while j = 1,2,3standfor bad, good and non-events,respectively. The differencesbetween
the daily return and (R/) and the averagereturn ( R lj ) are squared,addedtogetherand divided
by the number of post -event days (M).
Two F-statisticsare then calculatedto ascertaina
significantdifferencebetweenpositiveor negativeeventsandnon-eventreturns(seeTable 3).
Daily post-eventabnormalreturnsfor the two setsof eventsare computedand averaged
cross-sectionallyover the 60-day period following favorable and unfavorable observations.
These60-Day returnsare then addedto obtain the CARs for eachtype of news. Formally, this
implies that the abnonnalreturn for index i on day t (t
~
+ 1, ..., +60) following the unexpected
eventd, ARitd, is calculatedas by subtractingthe meanreturn of index i ( Ri3 ) from the daily
returnon the sameindex:
ARitd
= Ritd
-
Ri3
(3)
whered = 1, ..., n, denotesthe numberof favorableor unfavorableeventsin index i. Ritd is the
return of index i on day t for eventd, and Ri3 equalsthe meanreturn of index i for non-event
days. The meanabnormalreturn( ARi/) on day t is obtainedasfollows:
10
(
n
-1 L
~=
n
ARitd ) ,(1 =
d=l
+ 1.,
,+60).
(4)
The abnonnalreturn for every event( ARt,) is addedtogetherand divided by the number
of suchevents(n).
The Cumulative Abnonnal Return (CARil) is calculatedby adding the mean abnormal
returnsover t days( ARi/), suchthat
-
CARit= CARi(t- I)+ ARit.
(5)
The statisticalsignificanceof the CARs aredeterminedthroughthe applicationof the test
proposedby Ruback [1982], to accountfor the presenceof auto-correlation. The mathematical
expreSSIon IS:
t=
CARipt
(6)
[Var(CARiPf)]1/2
wherethe varianceis computedby
Var(CAR,P')
= d. Var(ARIld)+ 2.(d-l).Cov{AR'pi,AR'P(/+l»).
III.
(7)
Empirical Results
The current section summarizesthe statistical results and is divided into three parts.
The rust segmentis devotedto the comparisonbetweenpost-eventand non-eventvariances,as
documentedin Table 3. The following sectionscrutinizesthe cumulativeabnormalreturnsand
analyzes each stock market's adherenceto the Uncertain Information Hypothesis. This
discussionis aided by Table 4 and Figure 2. The final part addressesthe implications of the
statistics.
11
IV.l.
Statistical Interpretation of the Variances
The variances of the return volatilities following unexpectedshocks represent an
important test for the Uncertain Information Hypothesis. Brown, Harlow and Tinic [1988],
Ajayi and Mehdian [1994, 1995], Corsetti, Pesenti,and Roubini [1998], and Fleming and
Remolona [1999] find that unexpectedannouncementsproduce enhancedvolatility statistics.
Furthermore,variance volatilities following unfavorable disclosuresshould be greater than
volatilities following positivenews.
TABLE 3
Tabular Interpretation of Post-EventReturn Volatilities
12
(a)
F-statisticfor equality of post-eventandnon-eventvariances.
(b)
*
F-statisticfor equalityof postnegativeandpositive eventvariances.
Significantat the 5% level or better.
The summary depicted in Table 3 exhibits weak statistical support for the Uncertain
Information Hypothesis. For example, there are only nine significant casesof post-event
variancesout of a possible26 (F-statistic(a), column five). Denmark,Luxembourg,Portugal,
Switzerlandand Turkey recordno notabledifferencesin any variances.Greece,the Netherlands
and Swedenexhibit a significantspreadonly in the post-favorablecase.
f~
Belgium and Finland yield significant variability following both good and bad
observations. The remaining countries,Ireland Norway and Spain, yield significant statistics
only after unexpectedlyunfavorablenews.
The F-statistics(a) show that there is considerableadherenceto the EMH and weak
supportfor the UIH and OH. Only Belgium and Finland yield significant statisticsfollowing
both negativeand positive disturbances. Sixty days is evidently enoughtime for investorsto
digest the news and adjust their portfolios accordingly. The final answerto the question of
efficiency dependson the resultsof the next column.
Column six showsthat contrary to the Uncertain Information Hypothesis,most entries
exemplify greatervariancesfollowing favorable,ratherthan unfavorablenews. Yet the UIH is
supportedby the Belgium, Ireland,Norway, Spainand Turkey indexes. Although the Istanbul
bourseis apparentlyamongthe supportersof the UncertainInformation Hypothesis,it doesnot
yield a notable difference betweenpost-negativeand non-eventvariances(see column five).
However, it is still efficient becausethe returnsare not more volatile after a fluctuation in the
marketindex.
In summation,greaterreturnvariancesthan normal may in fact heralda rational response
to uncertainannouncements.Specifically,return variancesshouldbe larger following negative
rather than positive reports. Belgium, Ireland, Norway and Spain follow this rule and they
therefore sustain the Uncertain Information Hypothesis. However, Finland, Greece, the
Netherlandsand Swedendeviatefrom the aforementionedrule and displaycharacteristicssimilar
to the OverreactionHypothesis.
14
The arrival of unexpectedinformationdoesnot alwaystranslateinto increasedvolatilities
on the Europeanmarkets. Denmark,Luxembourg,Portugaland Switzerlandyield no significant
variancestatistics. This suggeststhe presenceof the Efficient Market Hypothesis.
IV.2.
Statistical Interpretation of the Cumulative Abnormal Returns
The cumulative abnormal return (CAR) data are more forthright than the variance
volatility statistics,sincethey constitutethe main testof marketefficiency.
15
FIGURE 2
Graphical Representationof the Cumulative Abnormal Returns
Denmark(negative)
0.80000
~
oct
U
QI
>
~
.~
Q.
0.20000
0.00000
-0.20000
~
..1.
3
4
5
10
20
30
40
50
60
.1
2
3
4
5
10 20 30 40 50 60
Post Event Day
Post Event Day
Finland (negative)
Finland (positive)
0.30000
ct:
0.20000
~ 0.10000
QI
>
~
.~
no
0.00000
-0.10000
-0.20000
1
2
3
4
5
10
20
Post Event Day
30 40
50 60
2
~
4
5
1~
20
Post Event Day
30
40
~
-':A
W
1.6
0.10000
0.05000
0.00000
«
00( -0.05000
(J
~ -0.10000
i
~Q
-0.15000
-0.20000
-0.25000
-0.30000
-0.35000
3
~
5
10
20
30
40
50
60
Post Event Day
Ireland (negative)
Ireland (positive)
0.10000
0.00000
~
c(
(.)
~
0(
u
~
>
~
"Ui
0
Q.
-0.10000
-0.20000
~
~ -0.30000
~
z -0.40000
-0.50000
-0.60000
2.
3
4
5
10 20 30 40 50 ~
Post Event Day
Post Event Day
Luxembourg(negative)
Luxembourg(positive)
~
oc(
(.)
Q)
>
It:
~
~
~
Ow
0
Q.
~
OJ
Q)
Z
1
2
3
4
5
10
20
Post Event Day
30
40
50
60
Post Event Day
~
If
~
~
~
~
~
C)
4)
z
z
~
4
5
10 20
30
40
50
60
30
40
50
60
Post Event Day
Norway (negative)
Norway (positive)
~
c(
u
0.1
0.05
0
-0.05
1.20000
1.00000
It:
~ 0.80000
-01
(,)
GI
GI
-!
~ 0.60000
m
Q
GI 0.40000
-0,15
'Vi
0
z
Q.
2
5
".4
10 20 30 40 50 60
5
Post Event Day
10
20
Post Event Day
Portugal(negative)
Portugal (positive)
0.6
0.20000
0.5
~
-c(
(J
GI
>
~
"Uj
0
Q.
It:
<
(.)
0.4
0.3
0..10000
~
~
IV
QI
Q)
Z
0.2
0.1
0
2
3
4
5
10
20
Post Event Day
30
40
50
60
1
2
3
4
5
cc
10 ~Q ~
Post Event Day
40 50 60
18
~
~
QI
>
~
Q
Q)
Z
0.40000
0.35000
0.30000
0.25000
0.20000
0.15000
0.10000
0.05000
0.00000
-0.05000
Post Event Day
Sweden (negative)
Sweden (positive)
0.16000
0.14000
~ 0.12000
..c
(J 0.10000
0.10000
0.05000
Ik:
.c(
(..)
~
~
"Vi
0
Q.
0.00000
~ 0.08000
'"a 0.06000
-0.05000
QI
Z 0.04000
-0.10000
0.02000
0.00000
-0..15000
t
2:
3
A
5
10 20
1
30 40 50 60
2
3
4
5
10 20
30
40
50
60
Post Event Day
Post Event Day
Switzerland (negative)
Switzerland (positive)
0.7
0.6
~
oct
U
Q)
>
~
'0
0
Q.
0.5
~
oc(
()
0;4
~
~
IV
~
Z
0.$
0.2
0..1
0
,
-0..1
.1
2
3
4
5
10 20 30 40 $0 6Q
Post Event Day
1
2
3
4
5
10
20
Post Event Day
30 40
5q $0
19
Turkey (positive)
Turkey (negative)
0.20000
0.00000
~
4(
U
QI
>
~
~
CI
QI
Z
-0.20000
-0.40000
-0.60000
-0 .80000
-1.00000
-1.20000
1
2
3
4
5
10
20
30
40
50
1.
60
2
3
4
5
10
20
30
40
Post Event Day
Post Event Day
TABLE 4
Summary of the CAR Results and their Correlation to the Adjustment Hypotheses
Recallthat the overreactionanduncertaininfonnation hypothesishavethe same
characteristicsfollowing unfavorableevents.
50
60
20
Figure2 and Table4 depict the resultsof the positiveand negativeevents. Thereis some
evidencesupportingthe UncertainInformationHypothesisin the favorablescenario. Six of the
thirteenmarketsrecordincreasingor non-negativereturnsfollowing positive news.
Luxembourg,the Netherlands,Norway andTurkey, however,yield negativereturns,implying
that investorsinitially overreactto the favorablenewsandset stockpricestoo high. This
observationis consistentwith the OverreactionHypothesis.
The remaining countriesyield inconclusiveresults. For example,in the first six days
following the disclosureof the favorableevent, the Finnish index declinesprecipitously. Yet,
from this point onward,the Helsinki bourseexperiencesa period of increasingreturns,identical
to the UncertainInfonnation Hypothesis. Thesereturnseventuallybecamepositive aroundDay
40. Greeceand Swedenexhibit the unpredictabilityassociatedwith strict efficiency.
For the 60 days following an unfavorabledisclosure,only six indexes(Denmark, the
Netherlands,Norway, Spain,Swedenand Switzerland)increase. The Netherlandsand Norway,
however, must be classified as supportingthe OverreactionHypothesis,basedon their CAR
figures following bad shocks. Turkey declines,implying adherenceto neither one of the three
theoriesand henceinefficiency. The remaining boursesexemplify inconsistencyin regardsto
both the UncertainInformationand OverreactionHypotheses.
The stock indexesof Denmark,Spainand Switzerlandare supportiveof the UIH in both
the post-favorableand unfavorablecases. The Netherlandsand Norway arejust as unwavering
in their supportfor the OH. Greece,Luxembourgand Portugalare experiencingpost-negative
returnsthat cannotbe classifiedundereither hypothesis:they are continuouslydeclining after a
certainpoint.
21
The Belgian, Finnish and Irish post-unfavorablereturns, as well as the Finish postfavorable statistics, manifest a pattern of reversal, unfamiliar to either the UIH or OH, yet
reminiscentof efficiency. Furthermore,the Greek and Swedishpositive abnormalreturns are
fluctuatingrandomly.
IV.3.
Summation and Implication of the Results
The propensityfor positive post-eventvariancesto be more volatile than the variances
following negativeevents,contraryto the UncertainInformation Hypothesis,may be relatedto
the natureof the exchangessurveyed. Namely, theseEuropeanmarketsare small in regardsto
the numberof securitieslisted, investorsand marketcapitalization. Usually, suchexchangesare
dominatedby a small numberof professionalswho respondto long- ratherthan short-runmarket
fluctuations.
However, if the favorablenewsgeneratesa conspicuousincreasein the rate of return, it
may attract new depositsto the market. This is true for all the boursespolled exceptthoseof
Belgium,Ireland,SpainandTurkey.
The OverreactionHypothesisis most consistentlysupportedby the Oslo and Amsterdam
exchanges. The aforementionedboursesrecord the abnormalreturn patternspredictedby the
OH, following both negativeand positive shocks. Moreover,the variancevolatilities of the two
marketsare significant only in the post-favorablecase,implying a lack of compliancewith the
UncertainInformationHypothesis.
Although the capital gainstax (28 percent)and the averagewithholding tax (15 percent)
in Norway reflect the Europeanmean,foreignershave faced barriersto investing before 1995.
22
Primarily, alien ownership,dependingon the sector,was limited to between33.3 and 40 percent
of eachfinn [Blackwell Finance,1996].
However,the sameexplanationdoesnot apply to the Netherlands,which hasone of the
oldest and most active bourses in the world.
Half of the listed securities are foreign.
Furthennore,non-residentsare not subject to either capital gains taxes or restrictions on the
repatriationof profits.
The explanationfor the presenceof market inefficienciesrestswith a distinction shared
by both the Dutch and Norwegian exchanges. Primarily, a large percentageof the securities
listed on the two marketsare energystocks:43 percentof the Amsterdamand 41 percentof the
Oslo marketcapitalizationis ownedby suchequities[Shachmurove,1996].
Turkish abnonnal returns decline following positive shocks, in accordancewith the
OverreactionHypothesis,as well. The Istanbulmarketis inefficient becauseit is generallymore
illiquid and restrictive than its continentalcounterparts,over the sampleperiod. One hundred
ninety one companiesare traded on the national market and the market capitalization figure
stoodat a mereUS$ 20 billion at the endof 1995[Blackwell Finance,1996].
Although there are no restrictionson foreign portfolio investmentand capital or profit
repatriation,a non-residentis facedwith a phalanxof taxes. Ankara imposesspecifictransaction
duties, usually directed at the volume of trade. Another impedimentto the Istanbul market's
integrationinto the global financial economyis a 44 percentcorporationtax levied on the saleof
securitiesand dividendsowedto foreign financial intennediaries.
Whereasthe Europeanmarketsdo not consistentlyexhibit increasedvariancesfollowing
an announcement,there is ample supportfor the UIH. For example,the CAR statistics(Figure
2) for Denmark,Spain and Switzerlandsupportthe UncertainInfonnation Hypothesisover the
23
given interval. The first two countrieshave variancevolatility levels reminiscentof the UIH's
predictions. Belgium, Ireland and Portugal yield both return and variance statisticsthat lend
further supportto this alteredefficiency model.
V.
Conclusion
Economistsassumethat individuals behaverationally. Consequently,investorsset stock
pricesto reflect all availableinformation. However,the existenceof efficiency in global security
exchangeshas been questioned. The critics point to the fact that the arrival of unexpected
announcements
leadsinvestorsto deviatefrom the efficiency paradigm.
Market disturbancesprompt the financial agents to undervalue securities following
negativenewsand overvaluestocksafter positive announcements.The OverreactionHypothesis
rejects the tenets of the Efficient Market Hypothesis. Smaller markets should be more
susceptibleto this sort of irrational behavior. However,with the exceptionof the Netherlands,
Norway and Turkey, evidenceis lacking to supportsucha claim. Yet all threeanomaliescan be
attributedto institutional factors.
An alteredversionof the EMH hasbeenchampionedas offering an accurateexplanation
of financial markets. The Uncertain Information Hypothesisstatesthat when faced with the
arrival of unexpectedinformation, foreshadowingincreasedinsecurityand risk, investorsprotect
their investmentpositionsby initially undervaluingequity prices. In the following periods,the
market experiencesincreasing or non-negative returns. This price adjustment should be
accompaniedby increasedreturnvariances.
This paper shows that the Europeaninvestorsoperating in the small continentalstock
exchangesgenerally react to uncertaininformation in an efficient and rational manner. These
24
agentsinitially set stock pricesbelow their marketvalue. Despitethe prevalenceof institutional
inefficiency,the marketssubsequentlyexperienceincreasedor non-negativereturns.
Moreover,the randompatternspredictedby the Efficient Market Hypothesisare evident
as well. Therefore,by adheringto the tenetsof the UncertainInformation Hypothesisand the
randomcoursetypical of the Efficient Market Hypothesis,the majority of the surveyedstock
exchangesare efficient.
25
Note
For American institutions see: DeBondt and Thaler, 1985, 1987, 1990; Howe, 1986;
Brown and Harlow, 1988; Brown, Harlow, and Tinic, 1988, 1989, 1993; Chan, 1988,
Davidsonand Dutia. 1989;Zarowin, 1989, 1990; Kaul and Nimalendran,1990,Lo and
MacKinlay, 1990, 1997, 1999, Aggarwal and Schrim, 1992, Conrad and Kaul, 1993,
Dissanaike, 1994, 1996, Loughran and Ritter, 1996, Ketcher and Jordan, 1994, and
Veronesi, 1999. For foreign marketssee: Corsetti, Pesenti,and Roubini, 1998, 1999;
Ratnerand Leal, 1999;Gunaratneand Yonesawa,1997,andHogholm,2000.
26
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29
STATISTICAL APPENDIX
TABLE
GO-Day Post-Event
A
Cumulative
Abnormal
Returns
30
~'
~c 1
32
33
""