Price Earning Ratio Effect: A Test of the Semi Strong Form of Efficient Market Hypothesis in Indian Stock Market

XI Capital Markets Conference, 21-22 December 2012, Indian Institute of Capital Markets (UTIICM)

8 Pages Posted: 3 May 2013

See all articles by VDMV Lakshmi

VDMV Lakshmi

Vignana Jyothi Institute of Management

Bijan Roy

ICFAI University

Date Written: April 23, 2013

Abstract

Proponents of Semi strong form of Efficient Market Hypothesis (EMH) claim that security prices fully reflect all publicly available information in a rapid and unbiased manner. Opponents of this Hypothesis question its validity by explaining various anomalies in stock markets. One such anomaly that they elucidate is Price Earning (P/E) ratio Effect, which is based on the premise that P/E ratios are indicators of the investment performance of a security and low P/E stocks have a tendency to outperform high P/E stocks even after adjusting for underlying risks.

The purpose of the study is to empirically test the relationship between P/E ratios and equity returns in Indian stock market based on monthly stock returns of 90 companies during the period April 2006 – June 2012 and thereby to examine the validity of semi strong form of EMH. The study applies Jensen, Sharpe and Treynor measures, which are based on Sharpe-Linter Capital Asset Pricing Model (CAPM) to test the risk- return relationships of these portfolios and to compare whether portfolio of low P/E stocks outperforms the portfolio of High P/E stocks. The study attempts to test, if there is any statistically significant difference between the returns of such a portfolio and a simple buy and old strategy. The study also attempts to examine if there is any statistically significant difference between the returns of Lowest P/E portfolio and Highest P/E portfolio using an alternative specification of CAPM. The findings of the study explain the superior performance of low P/E portfolio to high P/E portfolio, indicating the premium associated with cheap stock.

Keywords: Semi Strong Form, Efficient Market Hypothesis, P/E Effect, Buy and hold Strategy

JEL Classification: G11, G12 and G14

Suggested Citation

Lakshmi, VDMV and Roy, Bijan, Price Earning Ratio Effect: A Test of the Semi Strong Form of Efficient Market Hypothesis in Indian Stock Market (April 23, 2013). XI Capital Markets Conference, 21-22 December 2012, Indian Institute of Capital Markets (UTIICM). Available at SSRN: https://ssrn.com/abstract=2255389 or http://dx.doi.org/10.2139/ssrn.2255389

VDMV Lakshmi (Contact Author)

Vignana Jyothi Institute of Management

Hyderabad
India

Bijan Roy

ICFAI University ( email )

Hyderabad, Andhra Pradesh
India

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