# Methodology to analyze the dynamic behavior of investors in the Indian stock market

By Riya Jain and Priya Chetty on September 4, 2020

The study aims in understanding dynamism in the Indian stock market and formulating a model to analyze the dynamic behavior of investors. To this effect, investment in three different stocks i.e. income, growth, and value are studied. A previous article stated the need for this study. It elaborated that understanding the traits of the stock market is necessary in order to optimize an investor’s financial returns. This article builds on the methodology adopted for empirically analyzing the dynamic behavior of investors.

## Steps in the empirical examination of the dynamic behavior of investors in the stock market

### Step 1: Categorisation of stocks

It consists of categorizing the chosen stocks into three types: income, growth and value stocks based on the following financial ratios:

• Price-to-earnings ratio
• Price-to-book value ratio
• Dividend yield ratio

### Step 2: Risk-return analysis

This step pertains to analyzing the risk versus returns of stocks numerically. This evaluation is done using the following methods:

• Trend based analysis
• Momentum based analysis
• CAPM analysis

### Step 3: Formulating the model

This step deals with the presentation of the conceptual model that is formulated to maximize an investor’s returns from the stock market based on minimum risk.

The above stated methods are selected and then examination of each of the aspect is done based on the data derived from the secondary sources.

## Data collection procedure

Firstly, a sample of 303 BSE-500 index listed companies was selected for empirical examination for a ten-year period from 2009-2019 to understand the dynamic behavior of the investors. The names of these companies are as follows.

Financial data pertaining to these companies was extracted from online sources of information, such as the official websites of the companies, Moneycontrol.com and Rediffmoney.com. Variables that are considered for the examination are:

• Price-to-earnings ratio (P/E) or Earning Yield (E/P)
• Price-to-book value ratio (P/B)
• Dividend per share
• Opening and closing price of shares

The P/E ratio and dividend per share help in categorizing the stocks into income, growth, and value stocks. The formula for them is as follows.

Furthermore, the opening and closing price data for the BSE 500 listed top 303 companies would be collected from the official website of the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). This data would help in comparing the performance of the income, growth, and value stocks for the period April 1, 2000, to March 31, 2020. The formula for calculating return is as follows.

The table below shows the representation of the different variables considered for the stock market analysis and their sources.

## Data analysis procedure to understand the dynamic behavior of investors

The data analysis for the Indian stock market begins by categorising the 303 stocks into income, growth, and value stocks. This categorisation would be based on the P/E, P/B ratios and the dividend yield. The average value of the time period for each stock was calculated first. Criteria for categorisation of the stock is as follows.

Post categorisation, the assessment of the stocks’ returns would be done for examining and comparing the performance of different stocks. For this the below stated procedure would be followed:-

### Step 1

Descriptive analysis of the annual average returns for the period April 1, 2000, to March 31, 2020, in 5 groups i.e.

1. April 1, 2000 – March 31, 2005
2. April 1, 2005 – March 31, 2010
3. April 1, 2010 – March 31, 2015
4. April 1, 2015 – March 31, 2020
5. April 1, 2000 – March 31, 2020

Herein, the comparison across the 5 groups would help in providing more information about the movement of returns.

### Step 2

Trend analysis would be done for assessing the performance of the specific category with respect to the stock market. Herein the annual average return of the stocks would be individually compared with the market return of the BSE-500 index for each of the identified 6 groups.

### Step 3

A paired t-test based comparison would be done for a stock-wise comparison of the average return for the identified 5 groups. This comparative analysis of the stocks would help in knowing the performance of which stock is better. Herein, below stated hypothesis would be tested.

H01: There is no significant difference in the performance of the stocks

HA1: There is a significant difference in the performance of the stocks

### Step 4

Momentum analysis would measure the rise and fall in stock prices, thus providing information about the opportunity of earning momentum profit. Consisting of the two components i.e. formation and holding period; momentum analysis would be done for the short term and long term. Herein, term formation and holding period are be divided into the following:

Momentum would be determined by using the following formula.

### Step 5

A comparative analysis of momentum for the formation and holding period would be done using the paired t-test. This comparison would determine the earning opportunity of momentum profit in the case of each stock. Herein, for this below-stated hypothesis would be tested:

H02: There is no opportunity of earning momentum profit

HA2: There is an opportunity of earning momentum profit

### Step 6

In order to depict the performance of the stocks, comparative analysis among the stocks would be done based on the momentum value. Hereinbelow stated hypothesis would be tested using the paired t-test.

H03: There is no significant difference in the momentum hybrid performance

HA3: There is a significant difference in the momentum hybrid performance

### Step 7

CAPM based analysis for each of the stocks by determining the value of beta based on the risk-free returns. This would state investor behavior based on the possibility of risk in the market.

### Step 8

Lastly, for formulating the conceptual model, in order to predict the behavior of stocks, examination of the returns for the period April 1, 2000, to March 31, 2020, is done. Herein the below-stated procedure is followed:

1. Firstly, in order to formulate the model, the stationarity test is performed. This pre-condition test helps in stabilizing the time series and attains stationarity. Based on the result of the augmented dickey fuller (ADF test), the stationary form of variable is generated.
2. For assessing whether serial correlation exist in the time series or not, Correlogram is plotted. It helps in determining whether the current value is linked it with prior values or not. In presence of autocorrelation, appropriate lag value of moving average value is determined.
3. Partial correlation presence is assessed by examining the partial correlogram. If partial correlation is present that selecting the appropriate lag level, auto-regressive order is determined.
4. Using the ARIMA model, the linkage between the variation in the stock price and the time trend is built.
5. Lastly, based on the model, values for the stock price are predicted.

## How will these tests help to understand the dynamic behavior of investors?

The purpose of applying all the above stated tests in the stock market analysis is stated below.

Thus, following the above-stated tests and the specified procedure, assessment of the movements in the Indian stock market is performed, so that their future performance can be predicted in order to understand the dynamic behavior of investors and maximize returns.