Adaptive Vs Efficient: A Comparative Analysis of Stock and Foreign Exchange Markets in Pakistan

Abstract

The objective of this study is to evaluate the applicability of the Adaptive Market Hypothesis (AMH) to the Pakistan Stock Exchange (PSX) and the Foreign Exchange Market (FOREX). The study utilizes daily exchange rate data for the US Dollar, Euro, and British Pound against the Pakistani Rupee to analyze the dynamics of the FOREX market in Pakistan. In stock parallel, the study employs daily return data from the PSX. The dataset spans from January 2009 to December 2022. The methodology adopted in this study uses a rolling window analysis technique, which involves the division of the dataset into 350 windows. Subsequently, the researcher applied Augmented Dickey-Fuller (ADF) and Portmanteau tests (PT). The results obtained from the ADF test indicate the absence of a unit root in both the PSX and FOREX markets. It implies that the time series data is stationary, aligning with the Random Walk Hypothesis (RWH). Consequently, the findings suggest that market efficiency is predominantly upheld in the PSX and FOREX markets. Furthermore, the PT results reveal no evidence of autocorrelation between the PSX and US Dollar exchange rates. In summary, this study concludes that the financial markets, represented by the PSX and FOREX in Pakistan, exhibit a time-varying nature regarding efficiency, affirming support for the Adaptive Market Hypothesis (AMH). These findings suggest that, over time, market conditions change, and the market deviates from efficiency. Individual and corporate investors can utilize these insights to achieve better market returns, whereas these findings can aid practitioners and policymakers in devising effective frameworks to achieve desired outcomes.