Efficient Market Hypothesis (EMH)- the case of India's Foreign Exchange Market

Abstract

Efficient Market Hypothesis (EMH) propounded by the legendary finance professor Eugene F. Fama has come to be recognized as one of the most significant developments in the realm of finance theory. The enormous popularity of EMH may be vouched from the fact that the seminal paper -"Efficient Capital Markets: Review of Theory and Empirical Work" (Journal of Finance, Vol. 25, Issue 2) is counted one among the top cited papers of all time, as per the statistics available from Journal of Finance. While the ubiquity of EMH studies in respect of equity markets is appreciable, where academics have sought to examine the validity of the same in respect of diverse capital markets that include developed and developing economies; the lack of consensus emerging from empirical results make it difficult to lay any assertion on either acceptance or rejection of the theory. However, the gamut of research has certainly enhanced the richness of literature surrounding EMH. In recent times with the proliferation of trading in commodity and foreign exchange markets, it is useful to examine the validity of EMH in respect of these markets as well. In emerging markets like India, where commodity and foreign exchange markets have been growing at a phenomenal pace, an examination of EMH in respect of these neo-markets becomes imperative. The present study seeks to explore the validity of this theory, particularly, in respect of foreign exchange markets. The recent episodes of extreme currency swings and the ominous need to trace the underlying fundamentals contributing to the above phenomenon necessitate such a study, which makes it even more relevant. The inferences derived from the same are expected to enrich the theory and literature surrounding application of EMH in foreign exchange markets. The study begins with an introduction, which is followed by need for study that includes review of significant studies carried out on the above in Indian context. This is followed by a discussion on methodology describing the essential models, which is then empirically tested to draw appropriate inferences. The study ends with summary and conclusion.