Weak-form market efficiency and nonlinearity: evidence from Middle East and African stock indices

Abstract

This study examines the existence of nonlinear serial dependence in five stock markets in the Middle East and Africa. The results from the application of a battery of nonlinearity tests reveal that after removing all short-term linear dependence, the stock returns still contain predictable nonlinearities that contradict the unpredictable criterion of weak-form efficient markets hypothesis.

Acknowledgement

The author would like to thank Universiti Malaysia Sabah for giving him a scholarship to pursue his PhD study in Monash University.

Notes

¹ Patterson and Ashley (2000) and Kyrtsou and Serletis (2006) provided a review of those nonlinearity tests that are widely employed in the literature.

² The toolkit can be downloaded from Richard Ashley's webpage at http://ashleymac.econ.vt.edu/ashleyhome.html, while instructions and interpretations of all the tests are given in chapter 3 of Patterson and Ashley (2000).

³ The references and descriptions of these tests are deliberately omitted due to space constraint. The reader is to refer to the detailed discussion in Patterson and Ashley (2000).

⁴ Another limitation of conventional efficiency tests as criticized by Saadi et al. (2006) is that the detected autocorrelation could possibly due to non-synchronous trading, which is not genuine predictability but rather a statistical illusion. The above pre-whitening procedure not only obviates the need to adjust the returns series from the confounding effect of non-synchronous trading, but also addresses the interesting issue of whether stock returns are still predictable after removing linear dependence. See also Perron et al. (2002).