Effects of Market Reforms and External Shocks on Indian Stock Indices : Evidence on Structural Breaks and Weak-Form Efficiency

This study explores stock market efficiency in India after allowing for potential structural changes induced by reforms processes and/or external shocks. Failing to consider the effect of structural breaks while testing the efficient market hypothesis (EMH) could result in the flawed acceptance of the null of unit root producing a type-II error under conventional tests. Implementing modified versions of these tests, designed to address the presence of multiple breaks and identify additive and innovative outliers, this study re-validates the earlier findings on the EMH for Indian stock markets. The essence of our findings is that the major Indian stock indices do follow a random walk implying that the markets are weak-form efficient. The endogenous determination of structural break dates, using mostly Clemente, Montañés, & Reyes (1998) (CMR) methodology, allows us to identify important events in this respect. External shocks such as occasional stock market scams, policy and political regime changes, oil price shocks and the effect of global market meltdowns have caused abrupt or one time changes in the series mean (additive outlier model), while the reforms processes stand out to be the single most important cause for the gradual shifts in the level of stock indices (innovation outlier model). This underlines the importance of institution building and the domestic policy stance in countering external shocks