Estimating the Long-Run Determinant of the Efficiency of the Stock Market in India

Abstract

One of the prominent views is that development in a stock market has a positive impact on economic growth. The role of the stock market becomes important as it leads to capital formation in an economy which is used for producing goods and services in it, leading to growth in the real sector. However, it is only possible if the stock market is efficient enough to mobilise saving from a deficit spender unit to a surplus spender unit. Therefore, our study proposes to estimate the determinant of stock efficiency with the help of a fully modified ordinary least-squares model. The result of the analysis indicates that although both the risk-free interest rate and market capitalisation have a positive and significant impact on stock return, the impact of market capitalisation is larger. In terms of dynamic analysis, the error correction model shows that the speed of adjustment is around 50 per cent or time taken for re-establishing the long-run equilibrium is about two years. As market capitalisation is one of the important determinants of the efficiency of a stock market, the government should bring new reforms in the capital and money markets so that new financial innovations can be introduced in the market. Simultaneously, the regulation should be made to provide higher protection to the investor which further helps them to increase their confidence in the market.