Journal of Business Studies, Vol. XXVI, No.

2, December 2005

RETURN BEHAVIOR OF THE DSE-20:

AN EMPIRICAL INVESTIGATION ON THE DHAKA STOCK EXCHANGE

Dr. A. Sabur Mollah∗, Muhammad Zahedur Rahman†, Mohammad Saiful Islam‡

Abstract

This paper investigates the behavior of DSE-20 using daily DSE-20 Index and prices of the DSE-20
securities for the period of 2001-2003. A number of studies conducted on return behavior but most of them
are on the developed markets and none of them on the Dhaka Stock Exchange. Hence, the existing evidence
has limited relevance in identifying the return behavior of DSE-20. For the empirical analysis of this study,
ARMA, ARIMA, ACF, PACF, and Dimson’s Market model have been conducted. The ACF and PACF
suggest that the DSE-20 return series is a stationary time series. The empirical results also suggest that AR
(1) coefficient is not significant and all the evidence is against the weak-form market efficiency and proves
that the past price series can be used to predict the future returns. However, the results of the ARIMA imply
that the return series are following stationarity. The empirical evidence is consistent with Harvey (1993)
and Bekaert (1993), i.e., significant predictability in rates of return. As this study is particularly
concentrated on an emerging market, it will help the professionals in further understanding of financial
issues in the emerging markets and particularly markets in the Asian region.

JEL Classification: G14, G15

Keywords: Return Behavior, Efficient Market Hypothesis.

Introduction
Investors invest in financial securities for returns. They generally consider the ex-post
and ex-ante returns of the securities while making an investment decision. This is because
the investment in financial assets is always associated with different types of risks. So,
they try to have clear understanding about the return behavior in a world of uncertainty
and asymmetric information. Returns from investment are crucial to investors; they are
what the game of investments is all about. The measurement of realized (historical)
returns is necessary for investors to assess how well they have done or how well
investment managers have done on their behalf. It is also important to remember how risk

∗
Associate Professor, Department of Finance, University of Dhaka, E-mail: sabur0112@yahoo.co.uk
†
Senior Lecturer, Faculty of Business Administration, Eastern University, E-mail: m_zahedur@easternuni.edu.bd
‡
Lecturer, Department of Business Administration, Asian University of Bangladesh

Electronic copy available at: http://ssrn.com/abstract=997745

Journal of Business Studies, Vol. XXVI, No. 2, December 2005

and return go together when investing. Therefore, it is not sensible to concentrate on the
issue of return until and unless the consideration of the issue of risk because investment
decisions involve a trade-off between these two.

Different theories have been developed to find out the return behavior of financial
securities and empirical studies have been conducted in different financial environments
with diverse results. The study in this area is very much limited to the developing
economies. Hence, a study on Bangladeshi capital market is a crucial importance. This
paper attempts to investigate the behavior of stock returns of DSE-20, which consists of
leading companies. It presents what are, by now commonly used measures of the time
series behavior of rates of return. It also deals with the riskiness of the returns of these
leading securities.

The paper organizes as follows: section I is a review of literature along with major
empirical evidence, section II contains the description of data and sample, selection of
variables, and the methodology of the empirical analysis, the empirical results are
reported in section III, and finally, the summary and the concluding remarks are
incorporated in section IV.

I. Literature Review
Claessens et al. (1995) investigated the behavior of stock return in the twenty stock
markets, which include the presence of some of the return anomalies that have been
documented in other markets. It also presents what are, by now, commonly used
measures of the time-series behavior of rates of return. Claessens et al. made a distinction
between anomaly tests and time-series tests, both of which involve, implicitly or
explicitly, a test of an asset-pricing model. The distinction that was made is that the
anomaly focused on seasonal or cross sectional patterns in rates of return whereas time-
series tests focus on the predictability of rates of return over time. For both types of tests,
a very parsimonious model was used for rates-of-return behavior, i.e., rates of return are
independently and identically distributed. In this way it was tried to minimize the
problem of jointly testing a particular asset-pricing model and market efficiency.

Electronic copy available at: http://ssrn.com/abstract=997745

Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Sharma and Kennedy (1977) also examined the price behavior of a broadly reflective
stock market index of common stocks listed on the Bombay Stock Exchange (BSE). To
test the random-walk hypothesis they statistically examined both the randomness and
independence of the market index. The individual market results are then compared to the
results of equivalent tests of stock price indexes representing the New York Stock
Exchange (NYSE) and the London Stock Exchange (LSE). For that purpose, they used
two different tests, namely, a nonparametric test for randomness, by an analysis of runs
of consecutive price changes of the same sign and, a parametric test for independence,
which is an examination of the spectral densities of the data for any cyclical component
or periodicities.

DeBondt and Thaler (1985) find that when stocks are ranked on 3 to 5 years past returns,
past winners tend to be future losers, and vice versa. The attribute these long-term return
reversals to investor response to the information. In forming expectations, investors give
too much weight to the past performance of firms and too little to the fact that
performance tends to mean-revert.

Lakonishok et al. (1994) argue that ratios involving stock prices proxy for past
performance. Firms with high ratios of earnings to price (E/P), cash flow to price (C/P),
and book-to-market equity (BE/ME) tend to have poor past earnings growth, and firms
with low E/P, C/P, and BE/ME tend to have strong past earnings growth. Because the
market response to past growth, it is surprised when earnings growth mean reverts. As a
result, high E/P, C/P, and BE/ME stocks (poor past performers) have high future returns,
and low E/P, C/P, and BE/ME stocks (strong past performers) have low future returns.

Mitchell and Stafford (1997) show that seasoned equity offerings (SEOs) have strong
returns in the three years prior to the issue. It seems safe to presume that these strong
returns reflect strong earnings. It also seems safe to presume that initial public offerings
(IPOs) have strong past earnings to display when going public. If the market does not
understand that earnings growth tends to mean revert, stock prices at the time of the
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

equity issue are too high. If the market only gradually recognizes its markets, the
responses to past earnings growth is corrected slowly in the future.

II.a. Research Design

The empirical analysis of this study uses daily stock prices of twenty leading companies
of the DSE and the composite index of those securities in Dhaka Stock Exchange (DSE-
20) for the period of 2001-2003. DSE-20 includes (see Appendix 1) ACI, AMCL (Pran),
Aramit, Bata Shoe, BD Lamps, BOC, Beximco Infusion, Beximco Pharmaceuticals,
Confidence Cement, Chittagong Cement, GQ Ball Pen, Islami Bank, Meghna Cement,
Monno Ceramic, National Bank Limited (NBL), Padma Textile, Prime Bank, Quasem
Drycell, Singer BD and Square Pharmaceuticals. The data of daily price indices are
collected from the daily price quotations (officially published and unpublished documents
of the Dhaka Stock Exchange). The sample includes total 790 daily observations.
However, the study concentrates on the stationarity or hypothesizes the non-randomness
of the return series.

The rate of return on the securities during the sample period is defined as the daily
growth rate of the market price of the stock. It can be calculated as a ratio dividing the
capital gain (p t - p t-1 ) by the amount of the initial investment (p t-1 ) as follows:

p t - p t-1
rt = ………………………..(1)
p t-1
where,
rt is daily stock return, in period t;

p t is price at day t;

p t-1 is price at period t-1 and

II.b. Models
The most important issue in estimating time series models is to begin with a stationary
series, which is a stochastic process with a constant mean and variance over time. The
value of covariance between two time periods depend only on the distance or lag between
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

the two periods and not the actual time at which the covariance is computed. Financial
theory often suggests whether a series is expected to be stationary (excess returns) or
non-stationary (random walk). For general economic time series models, stationarity
becomes a murkier issue. The simplest test of stationarity is based on the so-called
autocorrelation function (ACF). In addition to the autocorrelation function test, we can
also check the pattern of partial autocorrelation function (PACF) plot against the lag
length.

In addition to the above statistical techniques, the study employs ARIMA (autoregressive
integrated moving average), the dynamic time series model to examine if the stock return
series depends not only on its past values of the return series but also past and current
disturbance terms. Theoretically the weak-form efficiency of the market persists when we
cannot predict the share prices from its historical price information. When the share
return can be predicted on the basis of data on past returns and on forecasted errors
together this gives rise to ARMA (autoregressive moving average) model (Cuthbertson,
1996). That is mean stock price is a function of its past values of stock prices itself or the
current and past values of the disturbance term. We also conducted the dynamic time-
series analysis using ARIMA model considering composite index of DSE-20.

ARIMA models are generalizations of the simple AR model that use three tools for
modeling the serial correlation in the disturbance: The first tool is the autoregressive, or
AR, term. The AR(1) model introduced above uses only the first-order term but, in
general, we may use additional, higher-order AR terms. Each AR term corresponds to the
use of a lagged value of the residual in the forecasting equation for the unconditional
residual. An autoregressive model of order p, AR(p) has the following form:

u t = ρ1u t −1 + ρ 2 u t − 2 + ...... + ρ p u t − p + ε t ……………………….(2)

The second tool is the integration order term. Each integration order corresponds to
differencing the series being forecast. A first-order integrated component means that the
forecasting model is designed for the first difference of the original series. A second-
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

order component corresponds to using second differences, and so on. The third tool is the
MA, or moving average term. A moving average forecasting model uses lagged values of
the forecast error to improve the current forecast. A first-order moving average term uses
the most recent forecast error; a second-order term uses the forecast error from the two
most recent periods, and so on. An MA(q) has the following form:

u t = ε t + θ1ε t −1 + θ 2 ε t −2 + ...... + θ p ε t − p ……………………..(3)

The autoregressive and moving average specifications can be combined to form an

ARMA(p,q) specification:

u t = ρ1u t −1 + ρ 2 u t −2 + ...... + ρ p u t −p + ε t + θ1ε t −1 + θ 2 ε t −2 + ...... + θ p ε t −p ………..(4)

Then we review the behavior of the rates of return on common stocks, which are
incorporated in the DSE-20 index. Because the casual observation of stock prices reveals
that when the market goes up (as measured by any of the widely available stock market
indexes), most stocks tend to increase in price, and when the market goes down, most
stocks tend to decrease in price. This particular finding suggests that security returns
might be correlated and this correlation might be obtained by relating the return on a
stock to the return on a stock market index. The return of stock can be written as

ri = αi + βi rm ……………(5)
where,
αi is the component of security i’s return that is independent of the market’s
performance –a random variable.
rm is the rate of return on the market index –a random variable.
βi is a constant that measures the expected change in rt given a change in rm

In this study DSE 20 index is considered as the market index. The preceding model was a
well-known single index model, which was introduced by Sharpe (1964). Later, Dimson
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

(1979) prescribed much more structured model compared to Sharpe. The equation of the
Dimson Model is as follows.

ri = α i + β1rm(t −1) + β 2 rmt + β 3 rm(t +1) ………………(6)

Where,
αi is the component of security i’s return that is independent of the market’s
performance –a random variable.
rm is the rate of return on the market index –a random variable.
β1 is a constant that measures the expected change in rt given a change in rm for
the previous year
β 2 is a constant that measures the expected change in rt given a change in rm.
β3 is a constant that measures the expected change in rt given a change in rm for

the following year.

III. Empirical Evidence

We perform autocorrelation function and partial autocorrelation function analysis for 20
lags of daily return series of DSE-20 index shows significant auto-correlation at different
lags, which is also true for the partial autocorrelations.

The outcome of ACF and PACF coefficient through EViews 3.1 are given below:

Table-1
Autocorrelation and Partial Autocorrelation Tests for Daily Returns
Lag AC PAC Q-Stat Probability
1 0.073 0.073 4.2753 0.039
2 -0.014 -0.019 4.4200 0.110
3 0.137 0.140 19.241 0.000
4 0.034 0.013 20.181 0.000
5 0.055 0.058 22.562 0.000
6 0.031 0.005 23.312 0.001
7 0.048 0.044 25.185 0.001
8 0.002 -0.020 25.188 0.001
9 -0.009 -0.013 25.258 0.003
10 -0.042 -0.059 26.649 0.003
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

11 -0.047 -0.043 28.430 0.003

12 -0.061 -0.063 31.463 0.002
13 -0.013 0.006 31.603 0.003
14 -0.049 -0.041 33.537 0.002
15 0.062 0.098 36.673 0.001
16 -0.032 -0.038 37.507 0.002
17 -0.073 -0.036 41.766 0.001
18 0.028 0.020 42.385 0.001
19 -0.009 0.001 42.449 0.002
20 0.029 0.038 43.145 0.002

The acceptance of null hypothesis is also supported by ACF and PACF plot. From both
the plots we see that there are one computed ACF and two PACF significant at 5%
significance level, however, their probability is close to zero.

Figure -1
Autocorrelation Function (ACF) for Daily Returns

RINDEX
1.0

.5

0.0

-.5
Confidence Limits
ACF

-1.0 Coefficient
1 3 5 7 9 11 13 15
2 4 6 8 10 12 14 16

Lag Number

In general, if a time series has to be differenced d times, it is integrated of order d or I(d).

Thus, if at any time we have an integrated time series of order 1 or greater, there will be a
nonstationary time series.
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Figure-2
Partial Autocorrelation Function (PACF) for Daily Returns

RINDEX
1.0

.5

0.0
Partial ACF

-.5
Confidence Limits

-1.0 Coefficient
1 3 5 7 9 11 13 15
2 4 6 8 10 12 14 16

Lag Number

By convention, if d = 0, the resulting I(0) process represents a stationary time series.

From the resulting PACF graph we also conclude that the DSE-20 index is a I(0) process.
That means, the ACF and PACF suggest that the DSE-20 return series is a stationary time
series.
Table-2
ARIMA (1, 1) Model Analysis
B SEB T-RATIO APPROX. PROB.
AR1 0.0700222 0.4937632 0.1418100 0.88726387
MA1 0.9960901 0.0085632 116.322840 0.00000000
RINDEX_1 0.0022936 0.0357378 0.0641800 0.94884377
CONSTANT 0.0000021 0.0000022 0.9364300 0.34934046

In order to make a preliminary judgment on p, q orders of ARMA model, we analyze

ACF and PACF of the series. On the basis of PACF analysis, we set p=1 and q=1.
Nevertheless, analysis of the model residuals reveals that they do not follow any specific
pattern and do not have significant autocorrelations.
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Table-3
ARIMA (1, 1, 1) Model Analysis
B SEB T-RATIO APPROX. PROB.
AR1 -0.78133012 0.11050775 -7.07036500 0.00000000
MA1 -0.86521679 0.08034506 -10.7687620 0.00000000
RINDEX_1 0.00523568 0.03571382 0.14660100 0.88348475
CONSTANT -0.00023870 0.00035398 -0.67434100 0.50029359

Results of the ARIMA analysis are presented in table-3. It suggests that the return series
are stationary. During the whole sample period ARIMA (1, 1, 1) is found as the best-
fitted model with AR1 coefficient (-0.78133012); and MA1 (-0.86521679). We perform
OLS estimation of its parameters, and find that AR (1) coefficient is not significant and
all the evidence is against the weak-form efficiency of the market and proves that the past
price series can be used to predict the future, Harvey (1993) and Bekaert (1993), also
found the same conclusion, i.e., significant predictability in rates of return.

Our results provide evidence for the existence of constant mean and variance for the
DSE-20 index, which demonstrate the stationary nature of the daily return. Nevertheless,
the stationary of the daily return series does not support the weak form Efficient Market
Hypothesis.
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Table-4
Dimson’s Model Analysis
Parameter
Name of the Company
αi β1 β2 β3
2.690E-04 -.112 .628 .214
ACI
(.754) (-2.999) (16.745) (5.714)
2.585E-04 -.190 .791 .231
AMCL(PRAN)
(.496) (-3.478) (14.428) (4.218)
7.978E-04 -.190 .879 5.839E-02
ARAMIT
(.549) (-1.249) (5.757) (.383)
4.815E-04 -6.330E-02 .350 -8.065E-02
BATASHOE
(.672) (-.843) (4.652) (-1.072)
3.089E-04 8.083E-02 .912 .260
BDLAMPS
(.299) (.747) (8.408) (2.401)
5.565E-04 -.139 .587 .138
BOC
(.697) (-1.655) (6.989) (1.646)
1.121E-02 -.831 -.317 1.124
BXINFUSION
(1.153) (-.816) (-.310) (1.101)
1.915E-03 -.338 1.502 -.163
BXPHARMA
(.676) (-1.139) (5.046) (-.550)
-9.399E-04 -.169 1.260 11.263
CONFIDCEM
(-.883) (-1.512) (11.263) (2.457)
2.515E-03 .829 1.300 .607
CTGCEMENT
(.663) (2.085) (3.260) (1.526)
3.693E-04 -.111 .708 8.656E-02
GQBALLPEN
(.775) (-2.222) (14.122) (1.730)
1.025E-03 -.122 .908 -7.499E-02
ISLAMIBANK
(.809) (-.917) (6.823) (-.564)
-9.276E-05 -.178 1.059 .376
MEGHNACEM
(-.139) (-2.539) (15.085) (5.357)
1.447E-04 -.134 .821 .183
MONNOCERA
(.135) (-1.190) (7.282) (1.625)
7.225E-04 -.188 .744 .165
NBL
(.616) (-1.527) (6.030) (1.342)
4.887E-02 -1.684 1.736 .800
PADMATEX
(1.756) (-.577) (.593) (.274)
8.557E-03 -.230 -.190 -.122
PRIMEBANK
(1.182) (-.303) (-.250) (-.160)
2.437E-05 -.279 1.058 .171
QSMDRYCELL
(.049) (-5.401) (20.433) (3.300)
4.034E-04 .101 .677 .125
SINGERBD
(1.008) (2.412) (16.101) (2.981)
5.135E-04 -.202 .979 6.289E-02
SQURPHARMA
(1.179) (-4.421) (21.388) (1.375)
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

In the empirical analysis, we tried to examine the relationship between the DSE-20
composite market return and the individual stock return. For this purpose, we typically
used the Dimson model, only reason of, it differs from Sharp’s model, who is the pioneer
of the market model. Instead of only daily market return, Dimson uses lag as well as lead
market returns, which give a vivid portrayal of risk-return behavior of DSE-20.

To analyze the Dimson model, we compare the individual market return of the stocks that
are incorporated in the DSE-20 for the period of 2001 to 2003, along with the daily, lag
and lead composite index return series. In all the cases, except for CONFIDCEM (-
9.399E-04) and MEGHNACEM (-9.276E-05), the coefficients of αi , i.e., the intercept of
the function are positive, which reveals that, all the securities endow with the risk
premium, which are reward for taking the systematic risk.

To measure the expected change in rt given a change in rm for the previous year, we used
lag of the return series. The above table 4 shows that, there is a negative relationship
between lag and individual stock return, which means that, if the lag return series of the
DSE-20 composite index goes up, say, by one point, the individual stock return is
expected to decrease by about the coefficient, i.e., β1 factor for the next day. Here also,
the exceptions are BDLAMPS (8.083E-02), CTGCEMENT (.829) and SINGERBD
(.101).

IV. Conclusion
This study investigates the behavior of stock returns of DSE-20 using daily data for the
period 2001-2003. The major objective of this study is to identify the time series behavior
of DSE-20 index and to deal with the riskiness of the returns of those securities, which
are included in the DSE-20. The empirical results of stationarity of time series returns
accepted the null hypothesis of ACF and PACF and identify the DSE-20 return series is
as a stationary time series. However, the empirical results suggest that AR (1) coefficient
is not significant and all the evidence is against the weak-form efficiency of the market
and proves that the past price series can be used to predict the future. This study employs
ARIMA, the dynamic time series model to examine the predictability to the future price.
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Results of the ARIMA analysis suggest that the return series are following stationarity.
The empirical results are consistent with Harvey (1993) and Bekaert (1993), i.e.,
significant predictability in rates of return. The stationarity of these effects suggests that
investors did not incorporate this knowledge into their trading strategies, as it would not
be consistent with the Efficient Market Hypothesis.

This study also compared the individual market return of the stocks that are incorporated
in the DSE-20 for the period of 2001-2003, along with the daily, lag and lead composite
index return series. All the securities, i.e., 18 out of 20 companies, endow with the risk
premium, which are reward for taking the systematic risk. As this study was conducted
on the DSE-20 Index, so, it is suggested similar studies should be conducted on the DSE
general and weighted index. This study will benefit the investors to judge the return
behavior of leading companies, more precisely the risk averse investors, as they usually
prefer to invest in blue chips. Further studies may be conducted on return behavior by
incorporating other explanatory variables covering different time dimensions.
Journal of Business Studies, Vol. XXVI, No. 2, December 2005

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Journal of Business Studies, Vol. XXVI, No. 2, December 2005

Appendix 1
SL No. Name of the Company
1 ACI
2 AMCL (Pran)
3 Aramit
4 Bata Shoe
5 BD Lamps
6 BOC
7 Beximco Infusion
8 Beximco Pharmaceuticals
9 Confidence Cement
10 Chittagong Cement
11 GQ Ball Pen
12 Islami Bank
13 Meghna Cement
14 Monno Ceramic
15 National Bank Limited (NBL)
16 Padma Textile
17 Prime Bank
18 Quasem Drycell
19 Singer BD
20 Square Pharmaceuticals