Efficient Market Hypothesis (EMH) continues to be controversial and debatable even in the 21st century. In the financial world many researchers have garnered ever greater empirical evidence of inefficiency, greatly discrediting EMH; however it plays a significant role in modern finance and therefore gives us an incentive for future research. There is a wide consensus that on the early stage stock markets in transition countries are obviously not weak-form efficient, due to the lack of information, irrational behaviour of participants and an overall lack of financial development. However, regulations, market structure and learning processes could create the framework to become relatively efficient markets.

The emerging stock markets in transition economies have attracted increasing attention from researchers. The vast majority of time-varying market efficiency research to date have been focused on European transition economies and no similar study on has been performed for post soviet countries except Russia.

The purpose of the current paper is to analyze financial market of one of the post soviet countries Kazakhstan and conduct comparative analysis of evolving market efficiency in a weak-form sense with Russian. The main objective is to identify which particular stock market becomes more efficient over time.

We used Kazakhstan Stock Exchange (KASE) and Russian Trading System (RTS) stock index prices at daily frequency covering time series from 1st of July 2005 to 1st of July 2010. After the detailed analysis of the structure and regulations of KASE and RTS the analysis is carried out at two stages. First, we estimate an AR (1) model and a GARCH model for the stock indexes. Then we estimate our AR (1) model with time varying coefficients and GARCH type errors. Finally we find varying levels of efficiency and varying speeds of movements toward relevant efficiency.

INTRODUCTION

The main objective of this paper is to test whether the Russian market, the most important amongst the so-called transition economies markets, has evolved towards some degree of efficiency since its foundation.

The EMH has been the central proposition of finance since the early 1970s and is one of the most contoversial and well-studied propositions in all the social sciences.

Regardless of whether or not one believes that markets are efficient, or even whether they are efficient, the efficient market hypothesis is almost certainly the right place to start when thinking about asset price formation. One can then consider relative efficiency.

It is interesting to analyze Russian financial markets for several reasons. First, financial market behavior in Russia can be different than in other emerging markets due to historical, cultural, and institutional factors. Second, Russian markets may offer better diversification benefits (Rockinger and Urga, 2000). Third, since the early 1990s, Russian policy makers have implemented major economic and financial reforms, resulting in the emergence of new financial instruments. A related question in this respect is whether investors in this market react to “news” in a similar fashion as those in advanced market economies. Fourth, because Russia is rich in energy resources, oil price shocks may have destabilizing effects on domestic financial markets. Fifth, a significant drawback with respect to financial market liberalization took place in 1998, and it is interesting to analyze the consequences of this development for the internationalization of Russian financial markets.

PART I: LITERATURE REVIEW

1.1 MARKET EFFICIENCY HYPOTHESIS AND CONCEPT OF EFFICIENY

‘A market in which prices always “fully reflect” available information is called “efficient.”-‘ [Fama (1970)]

The EMH puzzled many researches and economists from 20th century, many research papers have been written to provide empirical evidence either for or against EMH in order to assess its suitability for estimation and determination of stock price.

The EHM was first expressed by Bachelier (1990) in his thesis “The Theory of Speculation” being the first to model stochastic process (Brownian motion). The EMH was developed by Eugene Fama in 1960s. Fama (1965) first defined “efficient market” as a market which adjusts rapidly to new information. In his empirical analysis he concluded that stock market prices follow random walk and series of price changes have no memory. First formal economical argument against EHM was provided by Samuelson (1965). In his article “Proof that properly anticipated prices fluctuate randomly” inspired by Bachelier’s (1990) work, he focused on the concept of stochastic process rather than a random walk.

Roberts (1967) coined the term “efficient markets hypothesis” and made the distinction between weak and strong form tests, these distinctions were developed further by Fama (1970) and became the classic classification of there level of efficiency. In accordance to revolutionary framework of Fama (1970) there are three forms of efficiency:

Weak form efficiency – security prices fully reflect