Variance-Ratio Tests and High-Frequency Data: A Study of Liquidity and Mean Reversion in the Indian Equity Markets

Abstract

This paper tests for market efficiency at high-frequencies of the Indian equity markets by studying the behaviour of serial correlation in firm stock prices. We do this using the Variance Ratio test using returns data at a frequency of 5 minutes. We find that at this frequency interval, stocks show a pattern of mean-reversion. We also find that different stocks revert at different rates. Microstructure literature suggests that there is a correlation between the efficiency of a stock price and the liquidity of the stock on the market. We examine this hypothesis with liquidity measured in terms of both trading intensity as well as impact cost. We find strong evidence that there is a link between the liquidity of a stock and the patterns of serial correlations in its market price at high frequency.

Keywords: Variance-Ratios, High-frequency Data, Market Liquidity