Testing Market Efficiency with the Top-20 Index in the Mongolian Stock Market
Authors:   Asia-Europe Perspective Association, Damdindorj Turtsetseg Damdindorj Turtsetseg , Rhee Joon-hee , Choi Sujung 
Published: June 2018

This paper briefly introduces a history of the Mongolian economy and the Mongolian Stock market (MSE), and investigates the Efficient Market Hypothesis (EMH) in the MSE using the sample of the Top-20 Index from January, 2005 to December, 2014.
The Mongolia is a fast growing country located in Central Asia and bordered by China to the south and Russia to the north. Interestingly, the Mongolia is the most sparsely populated independent country in the world in terms of its demographic characteristic. According to the World Fact Book, growth averaged nearly 9% per year in 2004-08 largely because of high copper prices globally and new production. The economy also had grown more than 10% per year between 2010 and 2013, largely on the strength of commodity exports and high government spending.
As the Mongolia has been growing by a government-oriented policies, the economy achieved 17.3% growth in GDP in 2011, which is the highest record in its history. Simultaneously, the industrialization based on extractive industries such as copper, gold, molybdenum, and so on is rapidly going on. Monetary and stock markets are also growing fast recording that the market capitalization in the MSE was US$ 83 million in 2006 as the world’‘s smallest stock exchange and increased US$ 2 billion by 2011.
The MSE was founded in 1991 as a venue primarily to facilitate the primary issuance of equity for the privatization of government-owned enterprises. Secondary market activity on bidding these shares in the MSE has commenced since 1995. The MSE is a key player in the financial markets of the country implying that the market is extremely important for the continued growth of the Mongolian economy.
However, its trading infrastructure is still in the very early stage relative to the other developed countries’ market infrastructures. For example, the market is open only for three hours each day, five days a week. According to the FRC report in 2014, the actively traded stocks in the MSE is around 30 firms which consist of 88.4% of the total MSE market capitalizations. In addition, only a small group of market participants actively trade shares of stocks, and the role of institutional investors helping the MSE more efficient in terms of information dissemination is very limited. Recently, the MSE made an effort to improve its technological capacity by adopting the Millennium IT Software Limited, a subsidiary of the London Stock Exchange Group, but the MSE is still in the early stage and needs to be developed in future.
We examine the Efficient Market Hypothesis (EMH) in the MSE in terms of its primary market index, the Top-20 Index. The Top-20 index is the most popular market index in the MSE. The Variance Ratio(VR) test suggested by Lo and Mackinlay (1988) is applied to test the random walk hypothesis in the MSE. If the null hypothesis where VR (q)=1 is not be rejected, they conclude that the stock price follows a random walk. Therefore, we may also conclude that the weak-form market efficiency (i.e., the random walk hypothesis) would hold if the null hypothesis is not rejected.
The VR test results provide evidence that overall the MSE does not follow the random walk hypothesis by rejecting the null hypotheses under various scenarios. This implies that the weak-form of market efficiency does not hold in the MSE. Finally, we suggest that the limited liquidity and passive market participation by investors would be main drivers of the weak-form market inefficiency in the MSE.