Behavior of stock returns in a developing market: The case of South Korea

This dissertation consists of three primary essays, namely, (1) the day-of-the-week effect in the Korean stock market, (2) the stock return volatility-volume relationship on the Korean equity Market, and (3) the volatility in the cash equity market before and after the introductions of index futures and index options. First, this dissertation examined the statistical properties of stock returns on the Korean Stock Exchange during the 1990s in order to determine the appropriate methodology. The findings indicated that Korean stock market return data is non-normal and non-i.i.d.; therefore, the GARCH methodology, which does not require the assumption of normality, was the preferred choice. Second, this study aimed at providing a comprehensive empirical investigation of the day-of-the-week effect in KOSPI and its ten sub-indices. This study found that the day-of-the-week effect has completely disappeared in the 1990s in Korea. This important conclusion held true irrespective of the sub-periods examined, and the methodology utilized to detect the day-of-the-week effect. Third, this dissertation utilized a time deformation market model, which is an extension of Lamoureux and Lastrapes (1990), to estimate the relationship between stock return volatility-volume. The findings indicated that for the KOSPI, its ten sub-indices, and 21 active individual stocks, the GARCH effects did not completely vanish upon the introduction of trading volume or lagged trading volume as a proxy of the information arrival. With the diagnostic tests, the results indicated that either contemporaneous volume or lagged-one volume as a surrogate for the information arrival in GARCH (1, 1) model could adequately capture the linear and nonlinear dependencies of the data of market indices. However, it was clear that the GARCH (1, 1) model was considerably more successful in capturing these dependencies in the data of individual stocks than in the data of market indices. Fourth, the investigation focused on the volatility of the cash equity index before and after the introductions of index futures (May 3, 1996) and index options (July 7, 1997). The findings of this thesis clearly indicated that the two introductions increased the volatility in KOSPI returns. This finding was unaffected by the definitions of return adopted, and with and without the exchange index adjustment. However, it can be concluded that the Korean won's exchange rate problems attributed significantly to the volatility of the stock returns. The examination was extended to ascertain if volume of index futures and index options conveyed the information not revealed in the stock market. The contribution of the trading volumes of index futures and/or index options utilized to designate the information flow to the market showed considerable inconsistency.