Cyclical Efficiency vis-à-vis Market Conditions: A Case of Casablanca Stock Exchange

ABSTRACT:In the context of the Adaptive Market Hypothesis (AMH), market efficiency is bound to change in relation to market conditions. Current literature on the AMH in the Moroccan stock exchange does not show the linkage between changing efficiency and market conditions. To fill this vacuum, this study investigated whether market efficiency changed in a cyclical version over time; and evaluated the effect of market conditions on return predictability in the Casablanca Stock Exchange. This study applied two definitions of market condition, namely the up and down versus bull, bear and normal conditions. In addition, the 2007 global financial crisis and political atmosphere were examined as fundamental conditions influencing return predictability. To achieve the objectives of the study, we analyzed daily stock returns from January 1998 to February 2018. We tracked time-variation in market efficiency by employing both the linear and nonlinear testing tools ranging from ADF, KPSS, autocorrelation, variance ratio and the Brock, Dechert and Schieinkman (BDS) tests. These tests were implemented by using a rolling window approach to derive monthly measures of return predictability. Subsequently, the dummy regression model was used to evaluate the market condition effect on return predictability. First, we showed that the weak-form efficiency of the Moroccan stock market is adaptive through the descriptive statistics, unit root, stationarity, autocorrelation, variance ratio and BDS tests. In other words, return dependence, particularly the nonlinear dependence, interchanges with independence over time. Secondly, there is high predictability during the 2007/2008 financial crisis and low predictability during the tense political condition. In conclusion, we found that the Casablanca Stock Exchange exhibits time-varying efficiency and that financial crisis and political atmosphere (general election) constitute key conditions that contribute to market inefficiency. These findings conform to the postulation of AMH, and we recommend that the time-varying behavior and effect of market conditions be considered by market participants in their interaction with the stock market. This suggests that investors' trading strategies must be adaptive to suit changing conditions.