arbitrage pricing theory and return generating process:a macroeconomic approach to indian stock ...

298 Pages·2012·1.9 MB·English

by  Shaji P N

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Thesis Submitted to the
Cochin University of Science and Technology
for the award of the Degree of
Doctor of Philosophy
Under the Faculty of Social Sciences

by
SSHHAAJJII PP..NN

Under the guidance of 
DDrr.. KK.. GGEEOORRGGEE VVAARRGGHHEESSEE  

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KOCHI – 682 022, KERALA
NOVEMBER, 2012
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Ph.D. Thesis under the Faculty of Social Sciences

Author
Shaji P.N
Research Scholar
School of Management Studies
Cochin University of Science and Technology
Kochi - 682022
Email: [email protected]

Supervising Guide
Dr. K. George Varghese
Professor (Rtd.)
School of Management Studies
Cochin University of Science and Technology
Kochi - 682022
Email: [email protected]

School of Management Studies
Cochin University of Science and Technology
Kochi - 682022

November, 2012
SSCCHHOOOOLL OOFF MMAANNAAGGEEMMEENNTT SSTTUUDDIIEESS
CCOOCCHHIINN UUNNIIVVEERRSSIITTYY OOFF SSCCIIEENNCCEE AANNDD TTEECCHHNNOOLLOOGGYY
KKOOCCHHII –– 668822 002222,, KKEERRAALLAA,, IINNDDIIAA

Dr.K.George Varghese Mob: [phone]
Professor (Rtd.) Email: [email protected]

Certified that the thesis entitled “Arbitrage Pricing Theory and
Return Generating Process: A Macroeconomic Approach to Indian Stock
Market”, is based on the bonafide research work done by Shri. Shaji. P.N,
under my guidance and supervision. It is further certified that the thesis is
not previously used for the award of any Degree, Diploma and Fellowship
or for awarding other similar titles of recognition.
He is permitted to submit the thesis to the university.

Kochi Dr. K. George Varghese
5th November 2012. (Supervising Guide)
I, Shaji.P.N, do hereby declare that the thesis entitled “Arbitrage Pricing
Theory and Return Generating Process: A Macroeconomic Approach to
Indian Stock Market” submitted to Cochin University of Science and
Technology, Kochi - 22, for the award of the Degree of Doctor of Philosophy
under the faculty of Social Sciences, is the authentic record of original and
independent research work done by me under the supervision and guidance of
Dr. K. George Varghese, Professor (Rtd.), School of Management Studies,
Kochi - 22. I further declare that this thesis has not previously formed the
basis for the award of any Degree or Diploma or Fellowship or other similar
titles of recognition.

Kochi – 22 Shaji P.N
5th November 2012 (Research Scholar)
As I look back into the days of toil and sweat I have to thank many who have
extended relentless support and encouragement to me during the completion of my
thesis.
First and foremost I take immense pleasure to express my sincere and deep sense
of gratitude to my supervising guide and mentor, Dr. K. George Varghese, for his
uphold zest, valuable suggestions, motivation and perfect auspices throughout the
course of my doctoral research. His understanding, encouragement and personal
guidance have provided a good basis for the present thesis.
I express my deep sense of gratitude to Prof. (Dr.) D. Rajasenan, faculty
member, Department of Applied Economics and former Dean of social sciences,
CUSAT, for his advice and support throughout my work. I am very thankful to him
for the many discussions, valuable advices and suggestions.
I am deeply indebted to Prof. (Dr.) M. Bhasi, Director, School of Management
Studies, CUSAT and Dean of Social Sciences, for his support and encouragement at
all stages of my research work. I express my heartfelt gratitude to Dr. S.
Rajithakumar, for his valuable suggestions and support as a doctoral committee
member throughout my research work.
I offer my profound gratitude to Dr. K.C. Sankaranaryanan, former Head of
the department of Applied Economics and Dean of Social Sciences, CUSAT, for his
help and encouragement during the period of my research. I would like to acknowledge
all the faculty members of School of Management Studies, CUSAT, for their valuable
suggestions and support throughout my work.
I wish to thank Dr. N. Balakrishana, Dr. S.M Sunoj and Dr.P.G.Sankaran,
Department of Statistics, Dr. S. Harikumar, Department of Applied Economics,
Cochin University of Science and Technology, Dr. T.M Jacob, Nirmala College
Muvattupuzha, Dr. N. Ajithkumar, CSES, Kochi, for their help and motivation in
the pursuit of my dreams.
I wish to register my thanks to Mr. Mohammed Kasim, Mr.A.O. Lindo, Dr T.G.
Saji, Mr. M.P. Premkumar, Mr. S. Sandeep, Mr. Jackson D’silva, Mr Bijith Abraham,
Mr. P.R. Suresh and Mr.Rajesh Raj, for their valuable suggestions and constant help. I
am also indebted to my fellow-scholars for their sincere encouragement and support.
I acknowledge with gratitude the help extended by the office staff and the
library staff of School of Management Studies, CUSAT, for their valuable support. I
acknowledge my special thanks to the authorities and staff of Cochin University of
Science & Technology for their help and co-operation.
I am most sincere and earnest in expressing my profound gratitude towards the
Manager, Sree Narayana Trust Colleges, Kollam, for permitting me to complete my
research work as a full time research scholar under Faculty Development Programme
(FDP) of University Grants Commission. I acknowledge the valuable help and guidance
offered by my colleagues in the college and office staff who had been somehow or other
instrumental in the accomplishment of my long cherished dream of a doctoral degree.
I thank all the teachers of my school days, graduation and post-graduation for
laying my foundations.
I wish to express my sincere gratitude to Binoop M.R, Indu Photos, South
Kalamassery for the timely completion of the Word Processing.
My joy knows no bounds in expressing my profound thanks to my beloved
family members. They have been selfless in giving me the best of everything and I
express my deep gratitude for their love and prayers, without which this work would
not have been completed. I am deeply indebted to them for motivating me in
effectively working and accomplishing my goal. I acknowledge all my dear relatives for
their assurance and good-will in every way.
It would not have been possible to write this doctoral thesis without the help
and support of the kind people around me, to only some of whom it is possible to give
particular mention here. It was a memorable life with all the exuberant souls under
the roof of Sarovar hostel and I thank all my warmhearted friends of Sarovar hostel
and the entire University for their help, support and encouragement throughout my
research work.
Last, but not the least, I am grateful to Almighty God for the grace and
benevolence bestowed on me, throughout my life and to complete this doctoral research
work.

Shaji. P.N
CChhaapptteerr 11
IINNTTRROODDUUCCTTOONN AANNDD RREESSEEAARRCCHH DDEESSIIGGNN................................................................................0011 -- 1199
1.1 Introduction-----------------------------------------------------------01
1.2 Empirical Studies – Indian context --------------------------------06
1.3 Research Gap---------------------------------------------------------08
1.4 Research Problem ---------------------------------------------------10
1.5 Importance of the Study---------------------------------------------11
1.6 Objectives of the Study----------------------------------------------11
1.7 Hypothesis of the Study --------------------------------------------12
1.8 Methodology ---------------------------------------------------------12
1.8.1 Framework----------------------------------------------------------- 12
1.8.2 Period of study------------------------------------------------------- 13
1.8.3 Data and source ----------------------------------------------------- 13
1.8.3.1 Stock market Data------------------------------------------------14
1.8.3.2 Macroeconomic Data--------------------------------------------15
1.8.3.3 Source of Data----------------------------------------------------15
1.8.4 Methods and Tools-------------------------------------------------- 15
1.9 Limitations of the Study---------------------------------------------17
1.10 Organization of the Research Report------------------------------17
References-------------------------------------------------------------------18
CChhaapptteerr 22
TTHHEEOORREETTIICCAALL BBAACCKKGGRROOUUNNDD AANNDD LLIITTEERRAATTUURREE RREEVVIIEEWW................................2211 -- 4444
2.1 Introduction-----------------------------------------------------------21
2.2 Capital Asset Pricing Model----------------------------------------22
2.3 Arbitrage Pricing Theory--------------------------------------------24
2.4 Statistical APT -------------------------------------------------------29
2.5 Macroeconomic APT------------------------------------------------32
References-------------------------------------------------------------------41
CChhaapptteerr 33
SSYYSSTTEEMMAATTIICC RRIISSKKSS AANNDD EECCOONNOOMMIICC VVAARRIIAABBLLEE SSEELLEECCTTIIOONN......................4455 -- 6677
3.1 Investment Climate and Credibility of Economy---------------53
3.1.1 FII Investments ----------------------------------------------------- 53
3.1.2 Foreign Exchange Reserve ---------------------------------------- 54
3.2 Investment and Credit Environment-------------------------------55
3.2.1 Money Supply------------------------------------------------------- 55
3.2.2 Banking systems Credit to Government (BCG)---------------- 57
3.2.3 Banking system’s Credit to the Commercial sector (BCC)--- 58
3.3 Cost Environment --------------------------------------------------58
3.4 Inflation Environment-----------------------------------------------59
3.5 Alternative Investment Environment------------------------------60
3.6 Growth Environment------------------------------------------------61
3.7 Dependency Environment -----------------------------------------62
3.7.1 Exchange Rate ----------------------------------------------------- 62
3.2.2 Export and Import--------------------------------------------------- 63
3.8 Liquidity Environment----------------------------------------------63
References-------------------------------------------------------------------65
CChhaapptteerr 44
FFOORREECCAASSTTIINNGG OOFF SSEELLEECCTTEEDD MMAACCRROO EECCOONNOOMMIICC VVAARRIIAABBLLEESS....................6699 -- 9999
4.1 Introduction ----------------------------------------------------------69
4.2 Forecasting: Theory and Methodology ---------------------------70
4.3 Trend models --------------------------------------------------------71
4.4 Model selection Criteria---------------------------------------------72
4.4.1 Adjusted R2 ---------------------------------------------------------- 72
4.4.2 Akaike Information Criteria (AIC) and Schwarz
Information Criteria (SIC)----------------------------------------- 72
4.5 Autoregressive Integrated Moving Average (ARIMA) Process----73
4.5.1 Autoregressive Model or AR (P) Model------------------------- 74
4.5.2 Moving Average Model or MA (q) Model---------------------- 74
4.5.3 Autoregressive Moving Average or ARMA (p,q) Model----- 75
4.5.4 Integrated Processes and the ARIMA (p, d, q) Model--------- 75
4.6 Augmented Dickey-Fuller (ADF) Test ---------------------------76
4.7 Box and Jenkins Methodology-------------------------------------77
4.8 Variables and Data --------------------------------------------------79
References-------------------------------------------------------------------99
CChhaapptteerr 55
DDIIVVEERRSSIIFFIICCAATTIIOONN AANNDD PPOORRTTFFOOLLIIOO SSEELLEECCTTIIOONN....................................................110011 -- 112211
5.1 Portfolio and Diversification ---------------------------------------102
5.2 Measure of Diversification -----------------------------------------104
References-------------------------------------------------------------------115
Appendix---------------------------------------------------------------------116
CChhaapptteerr 66
AANNAALLYYSSIISS ..................................................................................................................................................................112233 -- 114444 
6.1 Canonical Correlation Analysis------------------------------------125
6.2 Factor Model Test Results and Interpretation --------------------128
References-------------------------------------------------------------------140
Appendix---------------------------------------------------------------------141
CChhaapptteerr 77
CCOOMMPPAARRAATTIIVVEE AANNAALLYYSSIISS ..................................................................................................................114455 -- 118822
7.1 Comparative analysis- size of capitalization----------------------145
7.1.1 Large cap portfolio 2006------------------------------------------- 145
7.1.2 Mid Cap Portfolio 2006-------------------------------------------- 150
7.1.3 Small Cap Portfolio 2006------------------------------------------ 154
7.1.4 Comparative Analysis (size) - Interpretation ------------------- 158
7.2 Comparative analysis- Time period--------------------------------164
7.2.1 Large Cap Portfolio 2000------------------------------------------ 164
7.2.2 Large cap portfolio 1994------------------------------------------- 168
7.2.3 Comparative Analysis (period) - Interpretation ---------------- 172
Appendix---------------------------------------------------------------------178
CChhaapptteerr 88
CCOONNCCLLUUSSIIOONN AANNDD IIMMPPLLIICCAATTIIOONN ............................................................................................118833 -- 118899
8.1 Summary and conclusions------------------------------------------183
8.2 Implications-----------------------------------------------------------188
BIBLIOGRAPHY..........................................................................191 - 200
APPENDICES..............................................................................201 - 277