Skip to main content
SpringerLink
Log in

Level of efficiency in the UK equity market: empirical study of the effects of the global financial crisis

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

This paper investigates the effect of good or bad news (the asymmetric effect) on the time-varying beta of firms in the UK during good periods (booms) and bad periods (recessions). Daily data from twenty five UK firms of different sizes and from different industries are applied in the empirical tests. The data ranges from 2004 to 2010, which includes the current global financial crisis. The time-varying betas are created by means of the bivariate BEKK GARCH model, and then linear regressions are applied to test for the asymmetric effect of news on the beta. The asymmetric effects are investigated based on both market and non-market shocks. Most firms and industries seem to support the market efficiency hypothesis during both periods. However, the level of market efficiency seems to decline significantly from the pre-crisis to crisis period. Both the results of market efficiency and declining market efficiency from the pre-crisis to crisis periods provide ample evidence of the asymmetric effect of the financial crisis on the beta of UK firms.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. Harel et al. (2011) provide an analysis of efficient markets.

  2. Cho and Engle (1999), finding evidence of asymmetric effects in betas of US firms, claim that this implies that abnormities of stock prices can be explained by changes in expected returns through a change in beta, thus supporting the claims of Chan (1988) and Ball and Kothari (1989).

  3. Of course, the crisis has carried on beyond 2010.

  4. Veronesi (1999) presents a two state continuous time hidden Markov chain model to explain the stock market under-reaction to bad news in good times. We use a BEKK GARCH framework analysing the impact of good and bad news in good and bad periods and present empirical evidence for 5 major industry classifications leading up to and during the recent financial crisis period.

  5. Dwyer and Lothian (2012) state that cross-country evidence and analyses of individual countries suggest a common explanation to the cause of the financial crisis is likely to be based in rapid credit expansion and economic growth. Dias and Ramos (2013) study the behaviour of the banking sector of 40 countries during the period 2007–2010. They show that although there were periods of intense contagion, the impact was uneven among sample countries. Marsh and Pfleiderer (2012) provide a discussion of black swans and the financial crisis.

  6. However, Kamin and DeMarco (2012) conclude that issues with U.S. Sub Prime mortgages more plausibly were a wake-up call about banking problems around the world than a direct cause of those problems.

  7. See Shin (2009). Reflections on Northern Rock.

  8. In autumn 2008, financial markets did move very much in sync, with stock prices around the world falling by 30 % or more (Bartram and Bodnar 2009 ).

  9. On average the Index declined by approximately 10 % between the periods 2004 to 2007 and 2007 to 2010.

  10. These figures were sourced from the financial times and the BBC website.

  11. However, sentence et al. (2012) state that the substantial increase in the UK house prices and capital inflows associated with growth of private sector debt combined with a large financial sector exposed to foreign developments led many observers to expect a worse experience than has transpired.

  12. We thank the referee for suggesting the correlation and covariance tests.

  13. See Markowitz (1952), Sharpe (1964) and Lintner (1965) for details of the CAPM.

  14. According to Klemkosky and Martin (1975), betas will be time-varying if excess returns are characterized by conditional heteroscedasticity.

  15. Hansen and Richard (1987) have shown that omission of conditioning information, as is done in tests of constant beta versions of the CAPM, can lead to erroneous conclusions regarding the conditional mean variance efficiency of a portfolio.

  16. This is also referred to as the “leverage effect”.

  17. Christie (1982) shows that equity volatility is increasing in financial leverage, and hence there is a negative relationship between the variance of returns and the value of equity. However, Christie (1982) and Black (1976) point out that financial and operational leverage is not enough to fully account for the asymmetry of volatility.

  18. According to Brooks and Henry (2002), if the risk premium is increasing in volatility, and if beta is a proper measure of the sensitivity to risk, then time variation and asymmetry in the variance–covariance structure of returns may lead to time variation and asymmetry in beta.

  19. Thus we estimate the BEKK model for each firm to create 25 individual time varying betas.

  20. The BEKK description relies heavily on Choudhry and Jayasekera (2012).

  21. We estimate the BEKK GARCH to obtain \({\hat{\text{H}}}_{{ 1 2,{\text{t}}}}\) and \({\hat{\text{H}}}_{{ 2 2,{\text{t}}}}\) for each firm to estimate the betas.

  22. The ADF tests are applied with six lags maximum.

  23. Previous research by Braun et al. (1995) support the overreaction theory (asset mispricing) by finding a weak asymmetric effect in beta. They conclude, based on the evidence of the low frequency (weekly) data, that betas are not responsive enough to account for the differing return performances of "winners" and "losers", and thus support De Bondt and Thaler (1989).

  24. There are two possible explanations. (1) Leverage based—viewing equity as a call option for the firm’s assets—if the value of a leveraged firm drops, its equity becomes highly leveraged, causing an increase in volatility (Black 1976; Christie 1982). (2) Positive relation between volatility and the expected market risk premium—an increase in volatility increases the expected return which in turn lowers the stock price contributing to the asymmetric effect in volatility (Pindyck 1984; Poterba and Summers 1986; French et al. 1987; Bollerslev, Engle and Wooldridge, 1988; Engle, Ng and Rothschild, 1990; Campbell and Hentschel 1992).

  25. A zero order for AR in beta gives the beta extreme volatility implying complete stochastic behaviour analogous to a random walk. Given that beta is a time-varying process, zero order for AR does not seem to be a realistic model.

  26. “Appendix” shows how repeated attempts at predicting the oil price made by the US Department of Energy exhibited huge deviations from the actual price levels, thus serving to illustrate the difficulty in predicting the movements in the oil prices.

  27. This is intuitive as the demand for food is relatively inelastic.

  28. VSTOXX Index, developed by Deutsche Borse and Goldman Sachs is a measure of volatility in the Eurozone. It measures implied volatility on options across all maturities.

References

  • Agrawal A, Jaffe F, Mandelker G (1992) The post-merger performance of acquiring firms: a re-examination of an anomaly. J Financ 47:1605–1621

    Article  Google Scholar 

  • Asquith P (1983) Merger bids, uncertainty and stockholder returns. J Financ Econ 11:51–83

    Article  Google Scholar 

  • Ball R, Brown P (1968) An empirical evaluation of accounting income numbers. J Account Res 6:159–178

    Article  Google Scholar 

  • Ball R, Kothari SP (1989) Nonstationary expected returns: implications for tests of market efficiency and serial and correlation in returns. J Financ Econ 25:51–74

    Article  Google Scholar 

  • Bartram SM, Bodnar GM (2009) No place to hide: the global crisis in equity markets in 2008/2009. J Int Money Financ 28:1246–1292

    Article  Google Scholar 

  • Bernard V, Thomas J (1990) Evidence that stock prices do not fully reflect the implications of current earnings for future earnings. J Account Econ 13:305–322

    Article  Google Scholar 

  • Black F (1976) Studies of stock market volatility changes. In: Proceedings of the American Statistical Association. Business and Economics Statistics Section, pp 177–181

  • Bodurtha J, Mark N (1991) Testing the CAPM with time-varying risk and returns. J Financ 46:1485–1505

    Article  Google Scholar 

  • Bollerslev T, Engle RF, Wooldridge JM (1988) A capital asset pricing model with time varying covariances. J Polit Econ 96:116–131

    Article  Google Scholar 

  • Bollerslev T, Chou R, Kroner K (1992) ARCH modeling in finance. J Econom 52:5–59

    Article  Google Scholar 

  • Braun P, Nelson D, Sunier A (1995) Good news, bad news, volatility and betas. J Financ 50:1575–1601

    Article  Google Scholar 

  • Brooks C, Henry O (2002) The impact of news on measures of undiversifiable risk: evidence from the UK stock market. Oxf Bull Econ Stat 64:487–507

    Article  Google Scholar 

  • Campbell J, Hentschel L (1992) No news is good news: an asymmetric model of changing volatility in stock return. J Financ Econ 31:281–318

    Article  Google Scholar 

  • Chan KC (1988) On the contrarian investment strategy. J Bus 61:147–163

    Article  Google Scholar 

  • Cho YH, Engle R (1999) Time-varying betas and symmetric effects of news: empirical analysis of blue chip stocks. National Bureau of Economic Research. Working paper no. 7330

  • Chopra N, Lakinishok J, Ritter J (1992) Measuring abnormal returns: do stocks overreact? J Financ Econ 10:289–321

    Google Scholar 

  • Choudhry T (2002) Stochastic Structure of the time-varying beta: evidence from the UK companies. Manch Sch 70:768–791

    Article  Google Scholar 

  • Choudhry T, Jayasekera R (2012) Comparison of efficiency characteristics between the banking sectors of US and UK during the global financial crisis of 2007–2011. Int Rev Financ Anal 25:106–116

    Article  Google Scholar 

  • Christie A (1982) The Stochastic behavior of common stock variances: value, leverage and interest rate effects. J Financ Econ 10:407–432

    Article  Google Scholar 

  • Cusatis P, Miles J, Wooldridge J (1993) Restructuring through spinoffs. J Financ Econ 33:293–311

    Article  Google Scholar 

  • De Bondt WFH, Thaler R (1989) Anomalies: a mean-reverting walk down wall street. J Econ Perspect 3:189–202

    Article  Google Scholar 

  • Desai H, Jain P (1997) Long-run common stock returns following splits and reverse splits. J Bus 70:409–433

    Article  Google Scholar 

  • Dharan B, Ikenberry D (1995) The long-run negative drift of post-listing stock returns. J Financ 50:1547–1574

    Article  Google Scholar 

  • Dias JG, Ramos SB (2013) The aftermath of the subprime crisis: a clustering analysis of the world banking sector. Forthcoming Review of Quantitative Accounting and Finance

  • Dwyer GP, Lothian JR (2012) International and historical dimensions of the financial crisis of 2007 and 2008. J Int Money Financ 31:1–9

    Article  Google Scholar 

  • Dwyer GP, Tkac P (2009) The financial crisis of 2008 in fixed-income markets. J Int Money Financ 28:1293–1316

    Article  Google Scholar 

  • Engle R, Kroner K (1995) Multivariate simultaneous generalized ARCH. Econom Theory 11:122–150

    Article  Google Scholar 

  • Engle R, Ng VM, Rothschild M (1990) Asset pricing with a factor-ARCH structure: empirical estimates for treasury bills. J Econom 45:213–237

    Article  Google Scholar 

  • European Commission (2009) Economic crisis in Europe: causes, consequences and responses. European Economy

  • Fama E (1970) Efficient capital markets: a review of theory and empirical work. J Financ 25:383–417

    Article  Google Scholar 

  • Fama E (1991) Efficient capital markets: II. J Financ 46:1575–1617

    Article  Google Scholar 

  • Fama E (1998) Market efficiency, long term returns, and behavioral finance. J Financ Econ 49:283–306

    Article  Google Scholar 

  • Fama E, French K (1992) The cross-section of expected stock returns. J Financ 47:427–465

    Article  Google Scholar 

  • Fama E, French K (1993) Common risk factors in the returns on stocks and bonds. J Financ Econ 33:3–56

    Article  Google Scholar 

  • Fama E, French K (1998) Value versus growth: the international evidence. J Financ 53:1975–1999

    Article  Google Scholar 

  • Fama E, French K (2002) Testing trade-off and pecking order predictions about dividends and debt. Rev Financ Stud 15:1–33

    Article  Google Scholar 

  • Frazzini A (2006) The Disposition effect and underreaction to news. J Financ 61:2017–2046

    Article  Google Scholar 

  • French KR, Schwert GW, Stambaugh RF (1987) Expected stock returns and volatility. J Polit Econ 99:385–415

    Google Scholar 

  • Giannopoulos K (1995) Estimating the time-varying components of international stock markets risk. Eur J Financ 1:129–164

    Article  Google Scholar 

  • Grossman SJ, Stiglitz JE (1980) On the impossibility of informationally efficient markets. Am Econ Rev 70:393–408

    Google Scholar 

  • Hansen L, Richard S (1987) The role of conditioning information in deducing testable restriction implied by dynamic asset pricing models. Econometrica 55:587–614

    Article  Google Scholar 

  • Harel A, Harpaz G, Francis JC (2011) Analysis of efficient markets. Rev Quant Financ Acc 36:287–296

    Article  Google Scholar 

  • Ikenberry D, Lakonishok J (1993) Corporate governance through the proxy contest: evidence and implications. J Bus 66:405–435

    Article  Google Scholar 

  • Ikenberry D, Lakonishok J, Vermaelen T (1995) Market underreaction to open market share repurchases. J Financ Econ 39:181–208

    Article  Google Scholar 

  • Ikenberry D, Rankine G, Stice E (1996) What do stock splits really signal? J Financ Quant Anal 31:357–377

    Article  Google Scholar 

  • Jegadeesh N, Titman S (1993) Returns to buying winners and selling losers: implications for stock market efficiency. J Financ 48:65–91

    Article  Google Scholar 

  • Kamin SB, DeMarco LP (2012) How did a domestic housing slump turn into a global financial crisis? J Int Money Financ 31:10–41

    Article  Google Scholar 

  • Klemkosky R, Martin J (1975) The adjustment of beta forecasts. J Financ 30:1123–1128

    Article  Google Scholar 

  • Lakonishok J, Vermaelen T (1990) Anomalous price behaviour around repurchase tender offers. J Financ 45:455–477

    Article  Google Scholar 

  • Lesmond DA, Schillb MJ, Zhouc C (2004) The illusory nature of momentum profits. J Financ Econ 71:349–380

    Article  Google Scholar 

  • Lintner J (1965) The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Rev Econ Stat 47:13–37

    Article  Google Scholar 

  • Loughran T, Ritter J (1995) The new issues puzzle. J Financ 50:23–51

    Article  Google Scholar 

  • Malkiel GB (2003) The efficient market hypothesis and Its critics. J Econ Perspect 17:59–82

    Article  Google Scholar 

  • Markowitz H (1952) Portfolio selection. J Financ 7:77–91

    Google Scholar 

  • Marsh T, Pfleiderer P (2012) Black swans and the financial crisis. Rev Pac Basin Financ Markets Policies 15:1–12

    Google Scholar 

  • Michaely R, Thaler R, Womack K (1995) Price reactions to dividend initiations and omissions. J Financ 50:573–608

    Article  Google Scholar 

  • Muth J (1961) Rational expectation and the theory of price movements. Econometrica 29:1–23

    Article  Google Scholar 

  • Nelson DB (1991) Conditional heteroskedasticity in asset returns: a new approach. Econometrica 59:347–370

    Article  Google Scholar 

  • Pindyck RS (1984) Risk, inflation, and the stock market. Am Econ Rev 74:335–351

    Google Scholar 

  • Poterba TM, Summers LH (1986) The persistence of volatility and stock market fluctuations. Am Econ Rev 76:1142–1151

    Google Scholar 

  • Ritter J (1991) The long-term performance of initial public offerings. J Financ 46:3–27

    Article  Google Scholar 

  • Roll R (1986) The hubris hypothesis of corporate takeovers. J Bus 59:197–216

    Article  Google Scholar 

  • Schwert GW (1989) Why does stock market volatility change over time. J Financ 44:1115–1154

    Article  Google Scholar 

  • Sentance A, Taylor MP, Wieladek T (2012) How the UK economy weathered the financial storm. J Int Money Financ 31:102–123

    Article  Google Scholar 

  • Sharpe W (1964) Capital asset prices: a theory of market equilibrium under conditions of risk. J Financ 19:425–442

    Google Scholar 

  • Shin H (2009) Reflections on Northern Rock: the bank run that heralded the global financial crisis. J Econ Perspect 23:101–119

    Article  Google Scholar 

  • Spiess D, Affleck-Graves J (1995) Underperformance in long-run stock returns following seasoned equity offerings. J Financ Econ 38:243–267

    Article  Google Scholar 

  • Susmel R, Engle R (1994) Hourly volatility spillovers between international equity markets. J Int Money Financ 13:3–25

    Article  Google Scholar 

  • Timmermann A, Granger CWJ (2004) Efficient market hypothesis and forecasting. Int J Forecast 20:15–27

    Article  Google Scholar 

  • Veronesi P (1999) Stock market overreaction to bad news in good times: a rational expectations equilibrium model. Rev Financ Stud 12:975–1007

    Article  Google Scholar 

Download references

Acknowledgments

We thank an anonymous referee for several useful comments. Any remaining errors are the authors’ responsibility.

Author information

Authors and Affiliations

  1. School of Management, University of Southampton, Southampton, SO17 1BJ, UK

    Taufiq Choudhry & Ranadeva Jayasekera

Authors
  1. Taufiq Choudhry
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Ranadeva Jayasekera
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Taufiq Choudhry.

Appendix

Appendix

See Fig. 2.

Fig. 2
figure 2

US DOE oil price forecasts. Source: U.S. Department of Energy, 1998

Full size image

Rights and permissions

Reprints and permissions

About this article

Cite this article

Choudhry, T., Jayasekera, R. Level of efficiency in the UK equity market: empirical study of the effects of the global financial crisis. Rev Quant Finan Acc 44, 213–242 (2015). https://doi.org/10.1007/s11156-013-0404-6

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-013-0404-6

Keywords

JEL Classification

Search

Navigation