Financial Performance Indicators
The Financial performance indicators below highlight the security price movement of Gulf Keystone Petroleum.
Diagram 1 shows the share price movement of GKP before and after both RNS announcements. The stock chart clearly shows that during the dates 18th and 21st there was a greater demand for GKP shares causing the price to rise rapidly. This significant rise suggests that investors were optimistic even though no quantitative data had yet been released within the initial RNS statement. After the release of the subsequent RNS on the 22nd quantifying the oil discovery, the share price began to rapidly decline. Over the next four days the GKP’s security price eventually settled at 158p.
Diagram 2 shows the volume of GKP shares traded before after both periods of announcement. This basic line graph shows that immediately after the initial announcement on the 18th of March the amount of shares that traded hands that day greatly increased. Over the next six days the trading volume steadily dwindled, until volumes reached a similar level to those prior to the announcement.
Finally diagram 3 shows a line graph of the percentage increase/decrease of Gulf Keystone Petroleum’s share price compared with the UK’s oil and gas industry average (NMX0530) over the past 6 months. It can be seen from the results that GKP’s share price movement does show slight similarities when compared with NMX0530. Although it is clear that GKP’s variance is much more volatile.
Why Is Market Efficiency Interesting?
The Efficient Market Hypothesis (EMH) states that stock markets are efficient enough to incorporate and reflect all relevant information within the pricing of its securities, making it impossible to ‘beat the market’. The fundamental theory of EMH is that securities always trade at their fair value on the stock market, making it impossible for an investor to find and purchase a bargain. EMH states that it is practically impossible for an investor to outperform the overall market through publically available information, expert stock selection or market timing. The only way an can possibly obtain higher returns is by exposing their capital to a greater amount of risk.
Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed topic. Supporters such as Fama (1970) claim that undervalued stocks cannot exist in an efficient market and that trends cannot be predicted ether by fundamental or technical analysis such as market movements and charting.
Although the Efficient Market Hypothesis is a widely supported theory among academics it has also attracted an equal amount altercation, some of the main critiques include Pasour (1989), Shoustak (1997), Howden (2008) and O’Neil (2000). O’Neil for example suggests several theories on predicting the movement of ‘undervalued’ shares based on charting. Some of the techniques demonstrated by O’Neil are ‘cup with handle’ and ‘double bottom’ chart patterns. It could also be said that EMH does not consider market anomalies such as speculative bubbles; calendar effects, Brusa et al (2005); company size, Dimson & Marsh (1986); and events outside a company’s control such as ‘Black Monday’ which occurred on 19th October 1987. On this day global stock markets crashed causing the values of company securities to severely diminish over a short space of time. By the end of October 1987 the UK’s FTSE 100 index had fallen by 26.45%. Showing evidence that stock prices can seriously deviate from their fair values.
Recent Relevant Studies
Fama’s (1970) theory on Efficient Market Hypothesis states that for a market to be truly efficient a security price must fully reflect all available information at any point in time. Although Fama points out that this type of ideal is an extremity and cannot be ‘literally true’. Within his paper ‘Efficient Capital Markets: a Review of Theory and Empirical Work’ Fama identifies and tests three feasible market models: strong form efficiency; semi-strong form efficiency; and weak form efficiency.
A study conducted by Kahnerman & Tversky (1973) on the physiology of prediction gave the opinion that individuals in revising there beliefs, tend to over-weigh recent information and under-weigh past data. This research set the way for studies on behavioral finance, in particular investor over-and under-reactions within the stock market. A seminal study of long-term stock market over and under reaction was conducted by DeBont & Thaler (1985), they found that individual investors do have the tendency to over-react to unexpected news and events whilst studying stocks listed on the Centre for Research Security Prices. They also concluded that based on market over-reactions there were elements of weak form efficiency within the tested stock market.
In the context of short term stock market over-reactions, two similar studies were conducted by Brown & Harlow (1988) and Howe (1986) both found strong evidence that an over-reaction hypothesis can occur over short periods of time.
A more recent study undertaken by Schnusenberge (2006) argues that there is more to market efficiency than the long accepted weak form and semi-strong form market models. Schnusenberge tested short term stock market over-and under-reactions in relation to DJIA and S&P indexes in an attempt to understand the psychology of investors and their effect on financial markets. The published article focuses on the stock market’s reaction to events before and after stock market highs. The research suggests that investors are cautious prior to stock market highs, but are overly optimistic following a stock market high. Schnusenberge also points out that once investors discover an overreaction their previous assessment is revised leading to a ‘stock price reversal’. Schnusenberge suggests that investors over-and under-reactions render stock markets inefficient.
Similarly a study on behavioral finance conducted by Basu et al (2008) presents compelling evidence supporting the idea that irrational investment behavior is a wide spread phenomenon and has serious implications on the global financial markets.
Testing Market Efficiency
This section will test three fundamental theories in relation to market efficiency in the case of the share price movement of GKP. The Author acknowledges that external events outside the control of GKP have had a dramatic effect on the company’s share price, such as civil and political unrest in the Middle East and Africa and the fluctuating price of oil. These events will not be considered within testing as it would be infeasible to consider all variables.
Theory 1, Investors Are Overly Optimistic Upon The Prospect Of Good News.
This section of theory will be tested in conjunction with Schnusenberge’s (2006) paper The Stock Market Behavior Prior and Subsequent to New Highs. Schnusenberge describes an overreaction as ‘a reaction than one that is considered normal in light of a simultaneous release.’ For the purposes of testing both RNS statements released by GKP are considered ‘new highs’. It can be seen that the results from diagram 1 are similar to Schnusenberge’s findings. In which he states ‘it is reasonable to believe that stock market precipitants are cautious prior to new stock market highs but are overly optimistic following such a new high’. It can be seen from diagrams 1 and 2 that on the 17th of March trading activity was minimal, suggesting that investors and potential investors were ‘cautious’. After the release of the initial RNS statement on the 18th the close price increased from the previous day by 28%, this was followed by a second consecutive increase in the close price of 10% on the 21st, suggesting investors were ‘overly optimistic’. After the successive RNS was released on the 22nd a ‘stock price reversal’ occurred, Schnusenberge states that this occurs when an investor upon discovering their overreaction, reconsiders their initial assessment. This caused the share price to eventually decrease settling at 158p on the 24th March. Hart, D (2011) speaking on behalf of Thompson Reuters also pointed out that the GKP’s oil find ‘is very much a qualitative thing at this point where people are probably leaning towards the higher estimates more so than the lower estimates’.
Theory 2, Share Price Reactivity
As illustrated by Diagrams 1 & 4 the base price on the 17th of March before the initial and subsequent announcements stood at 124p (close price). After the initial announcement was made on the 18th at 07:00 am GMT the share price opened at 141p, reaching a high of 166.43p during the day, although the price closed at 158.04p. On the 21st the share price opened at 166.5p reaching a high of 192.95p, although it closed at 174.21p. Similarly after the release of the subsequent RNS containing the results of testing on the 22nd at 07:00 am GMT the share price opened at 184.25p and climbed to 192.5, eventually closing on 174.61p. The timing of the share price movement in reaction to the release of both statements suggests that the market does in fact possess some semi-strong form characteristics. Although the market could also be seen to portray elements of weak-form efficiency as the share price fluctuated for a number of days after the release of the second RNS statement eventually stabilised at 158p. As seen in diagrams 1 & 4
Theory 3, Investor Rationalisation
Malkiel (1973) initially popularised the notion of irrational markets. He argued that the concept of investors making rational decisions based on market information was a non-existent model. According to Landberg (2003) investors upon trading in securities generally follow their emotions and not their minds. Basu et al (2008) claims that when a market is doing well investors behave as if the risk factor is reduced and are intent on chasing returns. However, once the market value of a security gathers momentum ‘loss aversion’ occurs. Basu states that generally investors become unwilling to hang on to their investments for very long, fearing a downturn in the security price so sell, locking in their profits. Based on diagram 1 on the 21st of March the share price opened at 166.5p and steadily climbed throughout the day to reach a high of 192.95p, it then steadily fell to close on 174.21p. This could suggest investors became more loss adverse and sold their shares at 192.95p. Although without being able to access individual investor motives this hypothesis is hard to prove.
Discussion & Conclusion
It appears that investors do trade cautiously prior to a ‘new high’ and with a greater amount of optimism subsequently in the case of GKP securities. The results from testing show that investor optimism was essentially greater than the actual result of oil prospects, causing an oscillation within the share price for several days prior to both announcements. Upon the realisation of the over-reaction a ‘stock price reversal’ occurred, causing the share price to eventually settle at 158p.
It could be seen from testing that there were slight anomalies within the security price of GKP and also in the time it took for the share price to absorb and reflect the relevant information. This suggests signs that the market is weak form efficient. Although the share price did convey an immediate reaction to both announcements, suggesting some characters of semi-strong form efficiency also.
It could be seen that there is a possibility that investors did act irrationally inline with research conducted by Basu et al (2008). The results indicate that irrational investor behavior may have contributed to the share price rise of GKP, then in turn a influential amount of shareholders fearing a downturn sold their shares causing the share price to fall rapidly. Although it can be seen that this type of result does follow both the share price movement and previous research conducted by Basu et al (2008) it must be noted that this result is limited as it does not take into account actual individual investor motives behind buying and selling of shares.
Finally the results show that although there is evidence of weak and semi-strong form efficiency, abnormal gains could have potentially been made by investors. This suggests that the short term share price movement of GKP deviates from the Efficient Market Hypothesis.
References & Recommended Further Reading
Basu, S., Raj, M., Tchalian, H., 2008. A Comprehensive Study of Behavioral Finance. Journal of Financial Service Professionals. July. pp 51-62.
Fama, E., 1970. Efficient Capital Markets: A Review of Theory and Empirical Work. Journal of Finance. Vol. 25 (2). pp. 383–417.
O’Neil, W., 2000. 24 Essential Lessons for Investment Success. New York. McGraw-Hill.
Schnusenberg, O., 2006. The Stock Market Behavior Prior and Subsequent to New Highs. Applied Financial Economics. Vol. 16. pp. 429-438.
Sen, A., 2011. UPDATE 2-Kurdistan oil find cheers Gulf Keystone investors. Thompson Reuters, [Online] 18th March. Available at: <http://uk.reuters.com/article/2011/03/18/gulfkeystone-idUKL3E7EI0XN20110318?type=companyNews> Accessed on 25th March 2011.
