Efficiencies in a least developed country: case of Malawi

Abstract

The neoclassical theory of Finance postulates the dominant hypothesis that markets are efficient, based on the premise that investors are perfectly rational. In addition, literature suggests that institutional investors play a controlling role in the financial system through ownership and trading of securities (Choi and Sias, 2009). However, recent studies in psychology have shown that investors have behavioral biases which induce trading patterns which violate the principles of rationality. Second, studies suggest that the trading behavior of institutional investors potentially moves prices away from fundamental values contrary to market expectations. Our thesis hypothesized that brokers use their principalness to generate higher profits than outside investors. Brokers have been documented as more likely to engage in price manipulation. Such studies have been widely investigated in emerging and developed markets. However, it has been found that empirical evidence of price manipulation is lacking in literature. In addition, studies suggest that economic agents act irrationally due to psychological bias and heuristics in their decision making. We therefore investigate the disposition effect, the tendency by investors to sell winners too early and hold onto losers for too long. This behavior is costly for investors and there is continuing debate among researchers about its underlying causes. Finally, our research investigates institutional herding behavior. This behavioral bias has potential price impacts such as destabilization of prices. Despite the small size of the Malawi market, illiquid stocks, few brokers and stocks, and that literature shows asymmetry of information as well as brokers’ use of their power to manipulate prices, the study finds that there is no evidence of trade-based manipulation. The study also finds no evidence of herd behavior amongst institutional investors indicating that investors do not imitate the trades of others. However, the study documents some evidence that investors sell winning stocks more readily than losing stocks. This disposition effect wanes over time and does not translate into momentum trading. Our findings contribute to the body of research that challenges market efficiency by documenting some evidence from a less developed country that is neglected in literature.