Case Study: of Abu Dhabi Stock Market Efficiency and Transmission Mechanisms

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¶ … Abu Dhabi stock market: Efficiency and transmission mechanisms

Like many of its neighboring countries, the United Arab Emirates has made enormous efforts in recent years in an attempt to reduce dependence on the dominant public sector and to provide private investors a bigger role in the economy. The purpose of this study was to determine whether the Abu Dhabi stock market is efficient, what type of analysis mechanism is best suited for identifying investment opportunities, and its implications for investors and the state. For example, the weak form of the efficient markets hypothesis suggests that it is impossible to earn superior risk-adjusted profits based on the knowledge of past prices and returns. To this end, this study examines the United Arab Emirates in general and the Abu Dhabi securities exchange in particular to determine whether these assumptions are accurate, and how they play out in real world settings. A critical review of the relevant, peer-reviewed, scholarly and organizational literature is followed by an analysis of stock market performance in the region and what these findings suggest for the future. A summary of the research and salient findings are presented in the concluding chapter.

Chapter One: Introduction

Statement of the Problem

Purpose of Study

Overview of Study

Chapter Two: Review and Analysis

Background and Overview

Stock Market and Economic Growth

Economic Performance in United Arab Emirates in General and Abu

Dhabi in Particular

Introduction to Abu Dhabi Stock Market

Abu Dhabi Stock Market Index and the Price of Oil

Chapter Three: Methodology

Chapter Four: Data Analysis

Determination of Efficiency of Abu Dhabi Stock Market

Chapter Five: Results and Findings

Chapter Six: Conclusion

Case Study of Abu Dhabi Stock Market: Efficiency and Transmission Mechanisms

Chapter One: Introduction

In the 19th century, the Trucial States of the Persian Gulf coast granted the UK control of their defense and foreign affairs; in 1971, six of these states, Abu Zaby, 'Ajman, Al Fujayrah, Ash Shariqah, Dubayy, and Umm al Qaywayn, merged to form the United Arab Emirates (UAE) and these states were joined a year later by Ra's al Khaymah (United Arab Emirates, 2007). Today, the UAE enjoys a per capita GDP that is on par with those of leading West European nations and the state's generosity with oil revenues and its moderate foreign policy stance have allowed the UAE to play an increasingly vital role in the affairs of the region (United Arab Emirates, 2007). This point is made by Al-Alkim, Al-Sayegh, Al-Shamsi and their colleagues (1999), as well, who report that, "By investing and reinvesting the nation's wealth in productive enterprises, the UAE has been transformed into a nation with one of the highest per capita incomes in the world and, arguably, the best quality of life in the Middle East. The gross domestic product is now $50 billion" (p. 2). Throughout the UAE, health care is free of charge, and the infant mortality rate is among the lowest in the world; likewise, education is also free and the UAE has one of the highest literacy rates in the developing world (Al-Alkim et al., 1999). In addition, during the period 1971 and the late 1990s, the UAE's population increased more than 15-fold and life expectancy increased from 60 years to 75 years (Al-Alkim et al., 1999). Given this environment, understanding how the Abu Dhabi securities exchange contributes to the nation's economic development has assumed new importance and relevance, and these issues are discussed at length further below.

Statement of the Problem

Like other Gulf Arab states, the United Arab Emirates has made enormous efforts in recent years in an attempt to reduce reliance on the dominant public sector and to provide private investors a bigger role in the economy (Abdou, Al Zarooni & Lewis, 2006). To this end, in recent years, the government of Abu Dhabi has implemented a number of initiatives designed to make privatisation part of this policy. Privatisation of public service entities has proven to be a successful experience in Abu Dhabi following the privatisation of the power and electricity sectors (Abdou et al., 2006). According to Eugene Fama's (1970) seminal study of market efficiency, the primary hypothesis following from quick and accurate reaction of stock market prices to new information is that stale information is of no value whatsoever in actually making money; therefore, in order to evaluate this hypothesis empirically, researchers need to define "stale information" and "making money." The first definition can be defined in a relatively straightforward fashion; however, defining "making money" remains a highly controversial issue (Schleifer, 2000).

In this regard, Schleifer (2000) emphasizes that, "The reason is that 'making money' in finance means making a superior return after an adjustment for risk. Showing that a particular strategy based on exploiting stale information on average earns a positive cash flow over some period of time is not, therefore, by itself evidence of market inefficiency" (p. 6). In order to earn this profit, an investor may have to bear risk and his profit may just be a fair market compensation for risk-bearing; however, there is a problem in measuring the risk of a particular investment strategy and demands a model of the fair relationship between risk and return. For this purpose, one widely accepted model is the Capital Asset Pricing Model; however, this is not the only available alternative. According to this author, "The dependence of most tests of market efficiency on a model of risk and expected return is Fama's (1970) deepest insight, which has pervaded the debates in empirical finance ever since. Whenever researchers have found a money-making opportunity resulting from trading on stale information, critics have been quick to suggest a model of risk -- convincing or otherwise -- that would reduce these profits to a fair compensation for risk-taking" (Shleifer, 2000, p. 6).

By contrast, the definition of stale information is much less controversial, and Fama differentiates between three types of stale information that provide the basis for three forms of the efficient markets hypothesis, the so-called weak form efficiency, wherein the relevant stale information is represented by past prices and returns (Shleifer, 2000). The weak form of the efficient markets hypothesis maintains that it is impossible to earn superior risk-adjusted profits based on the knowledge of past prices and returns. For instance, Shleifer reports that, "Under the assumption of risk neutrality, this version of the EMH reduces to the random walk hypothesis, the statement that stock returns are entirely unpredictable based on past returns. Past returns are not the only stale information that investors have. The semi-strong form of the EMH states that investors cannot earn superior risk-adjusted returns using any publicly available information" (2000, p. 6). In other words, as soon as information becomes public, it is immediately incorporated into prices, and an investor therefore is unable to gain by using this information to predict returns; as a result, a semi-strong form efficient market is obviously weak form efficient as well, since past prices and returns are a proper subset of the publicly available information about a security (Shleifer, 2000).

Purpose of Study

The purpose of this study was to determine whether the Abu Dhabi stock market is efficient, what type of analysis mechanism is best suited for identifying investment opportunities, and its implications for investors and the state.

Overview of Study

This study used a six-chapter format to address the research purpose identified above. The first chapter introduced the topic under consideration, provided a statement of the problem under investigation, as well as the purpose and this overview of the study. Chapter two provides the background and an overview, a discussion of stock market performance and economic growth, as well as an analysis of economic performance in the UAE in general and Abu Dhabi in particular. In introduction to the Abu Dhabi stock market is followed by an analysis of the Abu Dhabi stock market index and the price of oil. Chapter three describes more fully the research methodology used in the study, and chapter four provides an analysis of the data to determine the historic efficiency of the Abu Dhabi stock market. Chapter five presents the study's results and findings, and salient conclusions are provided in chapter six.

Chapter Two: Review and Analysis

Stock Markets and Economic Growth.

From a pragmatic perspective, efficient markets appear to help stimulate economic growth, but there are a number of assumptions involved. In the case of stock exchanges, for example, common stocks are traded on well-organized exchanges like the New York Stock Exchange or in dealer markets called over-the-counter markets in a process that facilitates the rapid execution of buy and sell orders (Batten, 2000). According to this author, "The price response to any change in demand caused by new information can be almost instantaneous. Such stock markets are also competitive due to the large number of participating individuals, institutions, corporations, and others. Competitive forces also tend to cause prices to reflect available information quickly" (Batten, 2000, p. 210). Markets that are capable of quickly and accurately reflecting available information… [END OF PREVIEW]

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