Diwali affecting the Indian stock market

Diwali is a festival celebrated in India in the month of November. The date of the festival varies from year to year. It’s a festival marked by happiness. Given its auspiciousness, the NSE opens the stock market for an hour on this day, which is referred to as “Muhurat trading”. The word “Muhurat” means auspicious. It is a symbolic and old ritual which has been going on for several years. It is believed that trading on this day, brings wealth and prosperity.  Diwali also marks the beginning of the fiscal year for several businesses. 

Historical information about market behavior at the time of Diwali is useful to make a generalization, if possible, about the effect of Diwali on the stock market and would allow arbitrageurs to make decisions based on this information. The key questions we can ask here is does Diwali lead to higher returns and higher volume of trade in the Indian markets?

The seasonal effect of Diwali violates the Efficient Market Hypothesis (EMH). EMH suggests that new information published will be taken into account by traders and will be reflected in the prices of stocks, thus, giving traders no opportunity for excess returns. The ability of investors to gain excess returns due to the seasonal effect of Diwali thus violates the EMH.

The literature presents some evidence of the effect of holidays on the stock markets, which is again a violation of the EMH. Lakonishok and Smidt (1984) confirm the existence of a year-end seasonal pattern in rates of return for small companies and suggest that there may be a seasonal pattern for large companies as well. Roll (1983a) finds significantly higher returns on the day prior to New year’s day and on the first 4 days of January.  Merrill (1966) finds a disproportionate volume of trades before holidays. Fosback (1976) finds higher returns of S&P 500 before holidays.

Given the literature on the effect of holidays on the stock market, it is natural to expect that Diwali will also have an effect on the stock market. Kumar (2012) looked at the returns 8 days before Diwali (including Muhurat trading) and 7 days after Diwali and found that the post-Diwali session witnessed higher returns but also witnessed higher volatility. Maheta (2014) also finds significantly higher returns in the 7 days post Diwali than the 7 days before Diwali. A look at the month-of-the-year effect reveals that November has significantly higher returns than other months (see Patel, 2011; Dash et al., 2011). A major contributor to this effect could be Diwali. It also found that the returns during the Muhurat trading Session is generally higher than the returns on the previous day. The studies carried out is on specific indices such as SENSEX and NIFTY which are assumed to reflect the movement of the entire market. However, it only reflects a majority of the market. Investors must take caution about the fact that not every share may observe the Diwali effect. The volume of shares traded also undergoes a change with respect to the Diwali effect. The volume of trade few days post Muhurat Session is also higher than the volume few days before the Muhurat session. The volume of trade on the Muhurat session has been rising over the years. 

Given the evidence from the market we can see that Diwali does have a significant effect on returns and volume of trade in the stock market. In particular, the post-Diwali session observes higher returns as well as higher volume of trade. It remains a question whether this arbitrage opportunity will fade away or remain in the years to come. However, the high volume is not likely to fade, given that people will buy shared on Diwali regardless of if there is a profitable opportunity. 

Academic References:

Agrawal, A., & Tandon, K. (1994). Anomalies or illusions? Evidence from stock markets in eighteen countries. Journal of international Money and Finance, 13(1), 83-106.

Ariel, R. A. (1990). High stock returns before holidays: Existence and evidence on possible causes. The Journal of Finance, 45(5), 1611-1626.

Dash, M., Sabharwal, M., & Dutta, A. (2011). Seasonality and market crashes in Indian stock markets. Available at SSRN 1785112.

Fields, M. J. (1934). Security prices and stock exchange holidays in relation to short selling. The Journal of Business of the University of Chicago,7(4), 328-338.

Fosback, N. G. (1976). Stock market logic: a sophisticated approach to profits on Wall Street. Inst for Econometric Research.

Kumar, U. (2012). Is There Any Diwali Effect?. Indian Journal of Finance, 6(3), 43-53.

Lakonishok, J., & Smidt, S. (1984). Volume and turn-of-the-year behavior. Journal of Financial Economics, 13(3), 435-455.

Maheta, D. Festival Effect in the Indian Stock Market.

Malkiel, B. G., & Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The journal of Finance, 25(2), 383-417.

Merrill, A. (1966). {Behavior of Prices on Wall Street}.

Patel, J. B. (2011). Calendar effects in the Indian stock market. International Business & Economics Research Journal (IBER), 7(3).

Roll, R. (1983). Vas ist das?. The Journal of Portfolio Management, 9(2), 18-28.

Sah, A. N. (2009). Stock market seasonality: A study of the Indian stock market. NSE Research Papers, University of Petroleum & Energy Studies, Gurgaon.

Permanent link