“Indian stock markets are inefficient and there is existence of rational bubbles” – A Study

There is no co integration between stock prices and dividends based on the linear approaches, indicative of the presence of "rational bubbles". However, based on the non-linear approaches the hypothesis of the existence of ‘rational bubbles’ in the Indian equity market is rejected. Further, it is observed that the negative deviations (from the mean) are eliminated at a faster pace compared to the positive deviations; above all, the stock price (and not the dividend) is responsible for most of the adjustments back to the equilibrium. The paper authored by Shveta Singh, Nishant Vats, Prof. P. K. Jain and Prof. Surendra S. Yadav of Department of Management Studies, IIT Delhi, analyzed the aspect of existence of "rational bubbles" in the Indian stock market. A research paper entitled “Rational Bubbles in the Indian Stock Market: Empirical Evidence from the NSE 500 Index“published in the recent June 2018 issue of Finance India – The Quarterly Journal of Finance.

The objective of this study is to test the presence of ‘rational bubbles’ in the equity market of India represented by the National stock exchange (NSE), using monthly stock prices and dividends data. The period of the study spans over nearly two decades, viz., January, 1996 to April, 2014 and the sample comprises of the 500 companies that constitute the NSE 500 index, based on their market capitalization. The methodology employed a range of linear (symmetric adjustment) and non-linear (asymmetric adjustment) co integration approaches.

The authors are unable to reject the hypothesis of existence of ‘rational bubbles’ in the Indian stock market, based on linear co integrating techniques, based on symmetric adjustment. Even the TAR approach indicates the presence of "rational bubbles" in the Indian stock market. In other words, the Indian stock market was inefficient, during the period of the study.

According to authors some more theories such as "greater fool" theory, the "herding" theory, the "extrapolation" theory and the "moral hazard" theories are perhaps also applicable to the Indian stock market which appears to be driven by emotions.

Other theories described "rational bubbles" a result of market manipulation in the presence of an "informal monopoly" and/or "informational oligopolies" which also appears to be the case with the Indian stock market which is dominated by large institutional buyers and traders.

The authors also suggested that even though there was volatility in the market, it remained clustered and the returns moved back towards the mean at a fast pace. Further, a co integrating relationship between the prices and the dividends, with an asymmetric adjustment characterized by sharp movements, is established. The results in the research indicate that the negative deviations from the fundamental value are adjusted faster as against positive deviations and the price (and not the dividend) is responsible for most of the adjustments.

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