International Journal of Arts & Sciences,

CD-ROM. ISSN: 1944-6934 :: 4(12):27–40 (2011)

Copyright c 2011 by InternationalJournal.org

ADAPTIVE MARKET HYPOTHESIS: EVIDENCE FROM INDIAN

BOND MARKET

Karthika S. Nair and M. Thenmozhi

Indian Institute of Technology Madras, India

This study investigates the predictability of bond returns and volatility by comparing the
predictability before and after the financial crisis and provides evidence of Adaptive Market
Hypothesis. The effect of macroeconomic variables such as industrial production index,
expected inflation, money supply, foreign exchange reserves, long term interest rates, short
term interest rates, exchange rates, LIBOR and forward premia on time varying volatility have
been measured using GARCH, and has been examined for three sub sample periods namely
2004-06, 2007-09 and 2008-09. The results show strong evidence of return as well as
volatility predictability for the second and third sample periods, which had the effect of
financial crisis. In particular, this study supports the materialization of the adaptive markets
hypothesis.

Keywords: Volatility, Macroeconomic variables, GARCH, Financial crisis, Adaptive Market

Hypothesis.

INTRODUCTION

Understanding the relationship between economic fundamentals of a country and that of its
financial market is not a new concept in the financial market literature. Ross (1976), (Chen, et al.
1986) validated the CAPM, APT model in the US securities market, where they empirically
proved that macroeconomic variables had a significant role in asset pricing. Further, many
authors extended their work in different markets of the world n and tested whether the market is
efficient using Efficient Market Hypothesis (Fama (1970)), so that in the long run investors can
predict the market. But, in the present scenario the validity of the hypothesis has been questioned
by critics, who blame the belief of rational market. Moreover, they failed to prove empirically
how macroeconomic factors are linked to the market. Due to the assumption that key
macroeconomic variables represented the economic states of a country, their arguments were
known as the “fishing license” of Fama (1991).
Though the Efficient Market Hypothesis (EMH) is viewed as keystone in finance which
used to be theoretical base for asset returns predictability and asset pricing, Lo (2004) established
that there is no consensus among finance academics and practitioners as to whether the stock
market is efficient. While Doran et al. (2010) found that majority of finance professors believe
that the market is weak form efficient. According to the EMH, more efficient the market, the
price changes are completely random and unpredictable. If EMH were true it should be possible
to generate higher expected returns after adjusting for risk. But in reality if we test a sample of
ten alternative investments, we can find that they exhibit excess returns, which implies that the

27
28 Karthika S. Nair and M. Thenmozhi

model is incorrect or markets are inefficient. This dilemma can now be rationalized within the
framework of Lo’s (2004) adaptive market hypothesis (AMH). Lo extended the EMH by
explaining market efficiency from an evolutionary perspective. The theory argues that constantly
changing market conditions determines the returns predictability in the financial market.
Therefore, he emphasized that the market efficiency cannot be evaluated in a vacuum, but is
highly context dependent and dynamic or more specifically it implies that return predictability
and investment profitability that arises from time to time depends on the demographics of
investors, financial institutions and market conditions. In recent years, some papers have found
strong evidence to support the theory. For example Kim et al. (2010) evaluated the evolution of
return predictability of the US stock market and checked whether the implications are consistent
with AMH. They found that return predictability is not driven by economic fundamentals but to
larger extent depends on dynamic market conditions.
In another study, Todea et al. (2009) investigated the profitability of moving average
strategy on six Asian Pacific capital markets, namely Australia, Hong Kong, India, Singapore,
Malaysia and Japan. They found that the strategy of moving average return is superior than buy
and hold passive strategy and found that the excess return varies over the time depending upon
the evolutionary process of the stock market. Thus, they said in their study that the degree of
market efficiency varies in a cyclical fashion over time and it was in line with the AMH
proposed by Lo (2004).

LITERATURE REVIEW

A review of literature with respect to stock market studies shows that authors have concentrated
primarily on verifying financial theories like APT (Gunsell et al.(2007)), CAPM (Corradi et al.
(2008) Engle et al. (2009), Shon (2009), Cakmakli et al. (2010)), where they find that economic
fundamentals have got the ability to predict returns and volatility. Similarly, there is a high
degree of interdependence between the economic variables and stock returns (Leitenmo et al.
(2009)).
The review of literature with respect to Treasury market also find a positive relationship
between macroeconomic announcement(surprises) and bond returns and volatility (Lumsdaine,
etal. (1998), Goeij et al. (2006), Christiansen (2000), Huang et al.(2008), Ernst Konrad(2009),
Ghosh(2010). Similarly, uncertainty about economic variables significantly affect the bond
returns and volatility(Arnold et al.(2010), Dick et al. (2010). Overall the review shows that
majority of studies pertaining to developed markets, especially US, are able to prove the general
hypothesis (between economic variable and asset returns) and existing theories.
In the recent years, some papers that have looked into the relationship between economic
factors, stock/bond returns and also the volatility aspect especially in the US market have thrown
much more insight to validate the existing finance theories. Gunsell, et al. (2008), extended the
approach of Chen, et al. (1986) by including industry specific factors like dividend yield and
sectoral unexpected production and examined the effect of macroeconomic factors on London
stock exchange. They considered different segment indices of the markets namely food,
beverage, construction, electronic, chemicals etc. and found that factors significantly affect the
market, but it is different for different sectors. They also found that there is a lagged effect in
some industries that contradicts the EMH and that there is no significant relationship between
unexpected inflation and stock returns because the market predicts the same as it is incorporated
in the stock price.
 Adaptive Market Hypothesis: Evidence from Indian Bond Market 29

Lucey et al.(2008) examine the impact of US macroeconomic surprises on stock returns of

Canada, France, Germany, Hong Kong, Italy, Japan, Singapore and UK. They have considered
within economy shock transfer and shock transfer between developed and developing markets
using variables like CPI, PPI, housing start, monthly unemployment, retail sales, personal
income, non farm payroll, IP index, business inventories, real GNP,GDP. They captured the
volatility in the markets using GARCH and find that US announcement affects both returns and
volatility, with IP announcement affecting the returns in all the countries, retail sales affecting
Asian countries, CPI negatively affecting the stock returns in Canada and non farm payrolls
adversely affecting the British stock returns. But the authors failed to explain the reason behind
the cross country differences in their work. Similarly, Nikolaos et al. (2009) examined the
relationship between crude oil, exchange rate, non-farm payrolls and 10 year government bond
yield on Dow Jones Sustainability index and Dow Jones Wilshire 5000 using GARCH model.
They find that crude oil and exchange rate negatively affect the stock returns, while bond yield
positively affect the returns. Corradi et al. (2008) examined how macroeconomic factors like
CPI, IP explain the fluctuations in the US stock market returns and volatility index. They
introduced a non-arbitrage framework based on the dimensional affine diffusion to predict the
fluctuation, and also highlighted that returns volatility is the outcome of two forces, the market
participant risk aversion and dynamics of the fundamentals. They find that stock returns are
procyclical and volatility is countercyclical. Leitemo et al. (2009) investigated the
interdependence between US monetary policy and S&P 500 using VAR methodology.
There were a vast number of studies that analyze the influence of monetary policy on stock
returns but few have attempted to model the interaction between monetary policy and asset
prices. The variables considered in the study include CPI, IP index, federal fund rate, commodity
price index. They find that there is high degree of interdependence between interest rate and
stock returns. Similarly, papers that looked into the volatility aspect of stock market like Engle et
al. (2009) introduced a class of component volatility model combining Spline GARCH and
MIDAS filters. They distinguished short and long run component of volatility and examined the
impact of IP index and inflation on the same. They find that the variable significance helps in
predicting the volatility. But the model does not consider liquidity related or event related
factors. Shon (2009) also investigated the relationship between stock market volatility and
economic factors in the US market. They have taken the same variable as of Engle et al. (2009)
but included additional factors for trading strategy like size and momentum. The short run and
long run component of volatility was captured using GARCH MIDAS model. They find that the
entire variable contains fair amount of information about future market volatility.
The US treasury market is regarded to be one of the efficient and developed markets in the
world. The market reflects most relevant information very quickly indeed and it is highly
affected by the economic fundamentals of the country when compared to the stock market,
which in most of the cases get affected by the firm related factors. The study of bond price
behavior in response to macroeconomic announcements has relevant implications for a variety of
issues. From the policy standpoint, it is important to understand the direction and size of the
market response to monetary and fiscal policy announcement. Some of the earlier studies like
Cornell (1983), Grossman(1981), Urich and Wachtel (1981) investigated the relationship
between interest rates to money supply. These studies were extended further by the inclusion of
new variables and methodologies. Majority of the papers have looked into the announcement
effect of economic variables on bond market.
Lumsdaine et al. (1998) examined the reaction of daily treasury bond prices to the release of
US macroeconomic news. They have taken PPI and employment data because they are released
30 Karthika S. Nair and M. Thenmozhi

on periodic, preannounced dates. They adopted the GARCH (1,1) model proposed by Bollerslev
(1986) to capture the asset return volatility and found that announcement day volatility does not
persist at all, due to the immediate incorporation of information into prices. Similarly, there is
risk premium on the release dates. If the markets know that a large shock is forthcoming, return
volatility decreases. This effect suggests the interesting interactions of volume, private
information, which is not addressed by the authors. While Christiansen (2000) examined the
effect of PPI and employment report news announcement on the covariance structure of US
government bond returns for six different maturity and find that the conditional variance is
greater on announcement days and it is also positive. The study was based on the approach of
Balduzzi et al. (1997). But a major eye opener among their findings was that the ultimate impact
of macroeconomic news announcement on bond returns depends on the general conditions of the
economy, i.e., whether it is in a state of recession or expansion. Goeij et al. (2006) validated the
EMH by examining the impact of 16 announcements on the conditional volatility of bond returns
using the GJR specification of Glosten et al. (1993) and found that among the announcement
FOMC affect the volatility of short term bonds, while employment news, PPI affects the
volatility of long term bonds. Huang et al. (2008) took four variables that represented real
activities namely Index of help wanted advertising in newspaper. Unemployment rate, IP index,
NAPM and three variables that represented monetary variables, namely, federal fund rates, non
borrowed reserves, M2 and examined the impact on bond returns volatility. They decomposed
the volatility into maturity dependent and bond market level volatility. The paper focused on the
long run predictability of bond volatility. The regression results found that real factors affect
volatility across all the maturity and monetary factors effects short and medium term volatility.
The major implication of this study is that the policy makers can employ monetary policy to
stabilize fluctuation in short and medium term bond and should consider real activity to stabilize
fluctuation in long term bonds. Ernst Konrad (2009) investigated the impact of monetary policy
surprises by the FED, Bundesbank /ECB on the return volatility of German stocks and bonds
using a GARCH-M model. He took IP index, CPI and percentage change in personal
consumption expenditure price index of US. He defined the monetary shock as the difference
between actual rate and the rate implied by the Taylor rule. The study found that the stock return
volatility is affected by monetary policy surprises of US, whereas monetary policy surprises in
Euro zone matter for bond return volatility. The result also suggested that the stock return
volatility can be negatively correlated with stock returns which contradict with the asset pricing
models like CAPM, ICAPM. Arnold et al. (2010), explores the fundamental determinants of
volatility in the US treasury bond market. They calculated daily bond returns for maturities of
30,10,5 and one year bonds. They measured the volatility based on Schwert and Stambaugh
(1987) model. They have taken the variables from Survey of Professional Forecasters and
calculated the cross sectional standard deviation of variables that represented the uncertainty
measure for each variable and found a strong link between uncertainty measures of the variables
(CPI, employment, IP index, real and nominal GDP) and bond market volatility. They have
calculated the ex-ante uncertainty of variables in the study.
Dick et al. (2010) validated the expectation hypothesis in the US market by investigating the
relationship between bond premia and macroeconomic variables. They took expectation about
real GDP and inflation as explanatory variables form Survey of Professional Forecasters and the
expected term premia was calculated for 10 year Treasury bond yield and 3 month T-bill rates.
They found that there is a strong link between macroeconomic developments and premia in bond
markets i.e. there is a positive relationship between premia and uncertainty about future output
growth and inflation rates. Similarly, Ghosh (2010) examined the relationship between
 Adaptive Market Hypothesis: Evidence from Indian Bond Market 31

announcement effect of the FOMC on exchange traded funds and treasury yield using GARCH
and ARCH model in the US market. He found that the announcements significantly affect the
conditional mean and variance of both ETF and treasury yields returns.
The literature survey predominately has been on developed markets and there were very few
studies focusing on emerging economies government securities market. Sabov et al. (1999),
examined the relationship between bond returns and inflation in Hungary market and found that
being a closed economy, the increase in prices do negatively affect the bond returns and
concluded that the findings are consistent with that of the studies undertaken by authors in
market economies. Similarly, Wu (2010) investigated the relationship between oil prices, bond
index returns and interest rates in Taiwan market and concluded that oil price changes affect
bond returns. Andritzky et al. (2005) examined the impact of macroeconomic announcement on
the emerging market bonds. They took the country sub-indices of the Emerging Market Bond
Index provided by JP Morgan for 12 emerging economies and examined the effect of
announcements namely, GDP, IP index, trade balance, fiscal balance, interest rate and country
ratings. By using dynamic panel regression and GARCH model, they found that all the
announcements affect market volatility and more specifically the bond market react to the
announcement changes in the international ratings.
The emerging economies government securities market, are now in a competing level with
that of developed market especially after the financial liberalization and global integration. We
believe that an empirical understanding of whether the bond prices and returns are driven by
economic fundamentals of a country and to check whether the market is developed and efficient
(in favor of AMH) will provide further insight to investors and policy makers. Further,
understanding the market volatility is also an important issue for practitioners and the Central
Bank. Engle (1982) and Bollerslev (1986) have captured the volatility dynamics of asset prices
in the early periods and later many authors extended their work and empirically tested the
relationship between economic variables, stock and bond return volatility in the developed
markets, but the concept has not been well researched in emerging market context. According to
the volatility puzzle (Schwert (1989)), financial market volatility seems disconnected from other
measures of economic volatility. This area need to be further researched in the emerging market.
This study differs from previous research in terms of the following: We examine the
changes in macroeconomic factors influence on bonds returns and volatility in three different
time periods to examine the effect of financial crises and also to empirically test the AMH in an
emerging market context. The results are compared it with the results on stock returns and
volatility changes in the three different periods.
The paper is organized as follows section 2 explains the data and methodology and Section 3
explains the results and Section 4 brings out the implications of the study.

DATA AND METHODOLOGY

The Indian Bond Market has been traditionally dominated by the Government securities market.
The reasons for this are (1) the high and persistent government deficit and the need to promote
an efficient government securities market to finance this deficit at an optimal cost, (2) a captive
market for the government securities in the form of public sector banks which are required to
invest in government securities a certain per cent of deposit liabilities as per statutory
requirement, (3) the predominance of bank lending in corporate financing and (4) regulated
interest rate environment that protected the banks’ balance sheets on account of their exposure to
the government securities. While these factors ensured the existence of a big Government
securities market, the market was passive with the captive investors buying and holding on to the
government securities till they mature. The scenario changed with the reforms process initiated
in the early nineties and late 2000.
32 Karthika S. Nair and M. Thenmozhi

Indian government securities market had a steady growth after financial liberalization of
early 1990's. Even though the market is dominated by the government securities, it is essentially
a vital part of Indian financial system. Indian government securities outstanding as on October
2010 were 2,054,467.38(in crores) (report from CCIL). As per the current statistics, the total size
of Indian debt market is estimated to be US$92 billion to US $ 100 billion, which accounts for
approximately 30 percent of its GDP. In terms of volume, it is larger than equity market and next
only to Japanese and Korean bond markets.
The study has taken the Total return bond index developed by Center for Clearing
Corporation of India Limited. The CCIL has developed mainly two bond index, total return
index and principal return index for India which act as a benchmark that facilitate measurement
of the performance of bonds across maturities. The Total return index for the bond is calculated
each market day by increasing the previous market days’ index value by the percentage change
in bond’s gross price. The gross price of a bond is its net price plus accrued interest. As far as the
index is concerned only top traded bonds, excluding bonds with maturities of less than 1.5 years,
special bonds like Oil bonds, Bonds with call and put option are taken for index calculation. The
specialty of total return index is that it tracks the capital gains and assumes that it is reinvested
back into the index. The S&P Nifty stock index has been considered for the stock index.
Based on the existing literature, the macroeconomic variables namely, industrial production
index, expected inflation, M3, foreign exchange reserves, short term interest rate (3month T bill
yield) long term interest rate (10 year government bond yield), real effective exchange rate,
LIBOR and forward premia has been considered. The data has been collected from Reserve
Bank of India website, Center for Clearing Corporation of India website and IFS and IMF
database.
The data constitutes monthly data from 2004 to 2009 since the bond index is available only
from 2004. The sample period of the study are subdivided into three periods in order to analyze
the hypothesis. The study has taken the period 2004 to 2006 that signifies the initial development
phase in the Indian bond market or the market innovation period, whereas the period 2007 to
2009 was taken that signifies the impact of financial crisis period and the third sub sample period
is from 2008 to 2009 that categorizes inflow of FII investment into bond market.
The study has used GARCH (1 1) model to compute the conditional volatility for bond
returns and stock returns. There are studies that have considered the realized volatility (Arnold et
al. (2010), Kim et al. (2009 ) but recent literature support the idea of using econometric models
to capture the volatility phenomena (Sariannidis (2009), Konrad (2009), Ghosh(2010)) so that
some of the interesting properties of volatility like volatility clustering and leverage effect will be
preserved in the analysis.
Fig. 1 to 5 shows the fluctuation in the bond and stock market of India for the entire period
and the sub-sample periods. With respect to the bond market, it is evident that the initial period
was not that attractive in terms of performance in comparison with stock market which shows an
upward trend during the same period. As per the Adaptive Market Hypothesis, the market is
dynamic and the predictability is cyclical in nature. The current study uses the same concept to
prove whether the bond return as well as volatility is predictable. There is sudden spike in the
bond return as well as volatility graph in the mid-2007. This shows that financial crisis has
positively impacted the Indian bond market, during this period and the market experienced a
sudden inflow in terms of investment into the government securities market(Flight to safety).
This reveals that the dynamic market condition makes the market more efficient (AMH) and
helps better prediction of the market movement.
The study uses factor analysis and Multiple Regression analysis to analyze the data. Since
there was high degree of multicollinearity among the macroeconomic variables, the variables
were factor analyzed and the factor scores were used to examine the effect of macroeconomic
factors on bond/stock returns and volatility.
 Adaptive Market Hypothesis: Evidence from Indian Bond Market 33

Figure1. Bond return and Volatility graph for the entire sample period.

Figure 2. Stock return and volatility graphs for the entire sample period.

Figure 3. Bond /stock return and volatility for the first sample period 2004 to 2006.
34 Karthika S. Nair and M. Thenmozhi

Figure 4. Bond /stock return and volatility for the second sample period 2007 to 2009.

Figure 5. Bond /stock return and volatility for the third sample period 2008 to 2009.
 Adaptive Market Hypothesis: Evidence from Indian Bond Market 35

RESULTS

The descriptive statistics for all the variables is given in Table1. The factor analysis of the
macroeconomic variables yielded different factors for each time period (see Table 2). For the
sample period 2004-06 and 2007-09, the factor analysis resulted in five factors which account for
86.8% and 82% variance respectively.

The factors emerged are the following:

Sample
1 2 3 4 5
period
Short term interest Expected inflation,
2004 to Reserves and IP
rate, long term LIBOR real effective
2006 forward premia index
interest rate, M3 exchange rate
Short term interest Real effective Expected
2007 to IP
rate, long term exchange rate, M3, inflation, LIBOR
2009 index
interest rate Reserves premia

In the case of sample period 2008-09, 6 factors accounted for 90% of the variance and the factors
that emerged are as follows.

Sample
1 2 3 4 5 6
period
Short term interest Real effective Expected
2008 to IP
rate, long term interest exchange rate, inflation, M3 LIBOR
2009 index
rate reserves premia

A multiple regression analysis using the five factors for three sample period shows that (See
Table 3) for bond/stock returns and return volatility; the significant factors influencing
returns/volatility are as follows:

2004-06 2007-09 2008-09

Bond returns None Expected inflation, Expected inflation,
premia, LIBOR premia, M3, LIBOR
Bond Volatility None LIBOR, IP index LIBOR, IP index
Stock returns LIBOR None None
Stock Volatility IP index Real effective exchange LIBOR
rate, M3, Reserves,
LIBOR

From the Table, it may be observed that the factors which were insignificant in the pre-crisis
period became significant after the crisis period. On the whole, the regression result indicates
that with respect to Indian bond market, high predictability is observed during the financial crisis
period. On the contrary, the predictability of stock market during this period is very less. The
high predictability of the bond market is possibly due to the reason that market became more
attractive for investors in comparison with stock market, i.e. the dynamic market condition
makes the market more efficient.
36 Karthika S. Nair and M. Thenmozhi

CONCLUSION

The AMH professed by Lo (2004) claims that return predictability is “highly context dependent
and dynamic,” where the constantly changing market conditions govern key market features. The
study found that during the periods of crisis, the bond market predictability improves in
comparison with that of stock market. Basically, the crisis is extreme events that often create
changes in any financial market. Therefore, the findings of this study are consistent with that of
AMH. Apart from this, the success of return or volatility predictability depends investors react to
the news. This often leads to under-reaction to the same or overreaction that subsequently affects
their investment decision. Similarly, the way the investors behave is also context dependent and
vibrant that is highly inclined towards the varying market environment. This study found
evidence that during crisis period the predictability improves which further validates the
Adaptive Market Hypothesis and the findings are similar to that of Kim et al. (2010) and Todea
et al.(2009). Overall, the finding can be considered as a materialization of the adaptive markets
hypothesis. However, there is scope to validate the model and the hypothesis by examining it in
other emerging countries such as Brazil, China, Russia, South Korea and Malaysia.

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 38
Karthika S. Nair and M. Thenmozhi
Table 1. Descriptive Statistics.

Short Long Real

Stock Industrial
Bond Bond Return Stock Expected Term Term Effective Forward
Return Production M3 Reserves LIBOR
Returns Volatility Returns Inflation Interest Interest Exchange Premia
Volatility Index
rate Rate Rate

Mean 0.0037 0.0002 0.0146 0.0074 1.0405 0.8686 0.0120 -0.0003 0.0001 0.0539 0.0129 -0.0438 0.0235
Median 0.0041 0.0001 0.0242 0.0068 1.0399 0.8900 0.0104 -0.0005 -0.0001 0.1600 0.0103 0.0154 0.0554
Std.Dev. 0.0153 0.0003 0.0864 0.0020 0.0611 5.3188 0.0660 0.0371 0.0360 1.6073 0.0304 0.3090 1.5091

Skewness 0.9852 4.5428 -0.9264 0.5516 0.4675 -0.5867 0.0788 -0.3801 -0.0558 -0.2210 -0.0948 -3.2503 0.2814

Kurtosis 6.6779 28.8339 5.3760 2.0156 3.7381 9.9147 8.0637 5.2336 4.9755 3.2297 3.0639 17.1515 4.2276
Jarque-
51.5027 2218.5720 26.8570 6.4674 4.1983 145.5202 75.9279 16.4694 11.5822 0.7342 0.1183 717.4614 5.3951
Bera
0.0000 0.0000 0.0000 0.0394 0.1226 0.0000 0.0000 0.0003 0.0031 0.6927 0.9426 0.0000 0.0674
Probability

Table 2. Component Factor Loadings of macroeconomic variables.

2004 TO 2006 Component 2007 TO 2009 Component 2008 TO 2009 Component

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 6
IP index -0.054 0.174 -0.036 -0.021 0.908 IP index -0.164 0.087 0.023 0.110 0.928 IP index -0.093 0.078 0.008 -0.074 0.094 0.962
EI 0.079 0.209 -0.163 -0.888 -0.079 EI 0.104 -0.073 0.918 -0.122 0.023 EI 0.073 -0.052 0.851 0.218 -0.215 0.138
STR 0.984 -0.028 -0.042 0.004 0.007 STR 0.979 -0.019 0.022 0.064 -0.057 STR 0.991 0.030 0.002 0.039 0.066 -0.050
LTR 0.983 -0.097 0.005 -0.014 -0.030 LTR 0.964 -0.010 0.024 0.067 -0.083 LTR 0.988 0.035 0.015 -0.053 0.061 -0.050
REER 0.009 0.394 -0.370 0.607 -0.391 REER -0.057 -0.760 0.222 0.064 -0.024 REER 0.121 -0.811 0.177 0.291 -0.079 -0.017
M3 -0.598 0.376 -0.060 0.258 0.399 M3 -0.469 0.611 -0.086 -0.167 -0.010 M3 0.034 0.021 -0.054 -0.947 -0.087 0.072
RES 0.124 -0.699 0.536 0.267 0.008 RES 0.026 0.745 0.276 0.185 0.055 RES 0.207 0.816 0.195 0.249 0.019 0.082
LIBOR -0.036 0.043 0.945 0.022 -0.037 LIBOR 0.168 -0.019 -0.096 0.929 0.089 LIBOR 0.128 0.062 -0.054 0.105 0.936 0.112
FP -0.134 0.854 0.161 -0.016 0.248 FP 0.213 -0.123 -0.532 -0.456 0.509 FP 0.112 -0.115 -0.705 0.296 -0.418 0.301
Note: TheTable shows the rotated component matrix for three sample periods, IP index is for Industrial production index, EI for Expected inflation, SIR for short
term interest rate, LIR for long term interest rate, REER for Real effective exchange rate, M3 for Money supply, RES for forex reserves, LIBOR and FP indicates
forward premia.
 Table 3. Effect of Macroeconomic Variables on Stock/Bond Returns/Volatility.
2004 TO 2006 2007 TO 2009 2008 TO 2009
Variables BR BRV SR SRV Variables BR BRV SR SRV Variables BR BRV SR SRV
REGR factor REGR factor REGR factor
score 1 for 0.040 -0.023 0.240 0.051 score 1 for -0.236 -0.236 0.047 0.031 score 1 for -0.236 -0.362 -0.066 0.015
analysis 1 analysis 1 analysis 1
[0.224] [-0.129] [1.497] [0.318] [-1.563] [-1.653] [0.264] [0.184] [-1.312] [-1.936] [-0.274] [0.075]
REGR factor REGR factor REGR factor
score 2 for -0.088 0.014 0.184 -0.070 score 2 for 0.159 -0.102 -0.217 0.308* score 2 for 0.109 -0.037 -0.068 0.315
analysis 1 analysis 1 analysis 1
[-0.499] [0.078] [1.151] [-0.438] [1.055] [-0.713] [-1.219] [1.841] [0.605] [-0.199] [-0.282] [1.604]
REGR factor REGR factor REGR factor

Adaptive Market Hypothesis: Evidence from Indian Bond Market

score 3 for -0.153 -0.239 -0.292* 0.154 score 3 for 0.320** -0.097 0.158 -0.058 score 3 for 0.411** 0.008 0.131 -0.167
analysis 1 analysis 1 analysis 1
[-0.865] [-1.337] [-1.825] [0.969] [2.117] [-0.681] [0.888] [-0.349] [2.280] [0.045] [0.544] [-0.851]
REGR factor REGR factor REGR factor
score 4 for 0.148 -0.019 0.121 -0.068 score 4 for -0.353** -0.440** -0.019 0.293* score 4 for -0.319* -0.161 0.111 0.173
analysis 1 analysis 1 analysis 1
[0.835] [-0.106] [0.756] [-0.424] [-2.335] [-3.076] [-0.105] [1.752] [-1.769] [-0.862] [0.462] [0.878]
REGR factor REGR factor REGR factor
score 5 for 0.199 -0.122 0.255 0.479** score 5 for -0.176 -0.373** 0.104 -0.065 score 5 for -0.360* -0.377* -0.165 0.369
analysis 1 analysis 1 analysis 1
[1.126] [-0.683] [1.591] [3.010] [-1.169] [-2.609] [0.584] [-0.386] [-1.996] [-2.016] [-0.684] [1.877]
REGR factor
score 6 for -0.116 -0.372* 0.064 -0.297*
analysis 1
R square 0.094 0.073 0.256 0.265 R square 0.339 0.408 0.085 0.189 [-0.644] [-1.985] [0.267 [-1.510]
AD R square -0.062 -0.087 0.128 0.139 AD R square 0.225 0.306 -0.073 0.049
DW 1.738 0.419 2.492 0.477 DW 1.366 1.297 1.750 0.352 R square 0.481 0.439 0.070 0.382
AD R square 0.286 0.229 -0.279 0.150
DW 1.108 1.248 1.547 0.608
Values are beta coefficients. Figures in [ ] are t-statistic. The factors are significant are 5%(**) and 10%(*) level. BR indicates bond returns. BRV
for Bond Returns Volatility, SR for Stock Returns, SRV for Stock Return Volatility.

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