Testing market efficiency in an ex-dividend setting - Could the market be efficient in the presence of inefficiency?

Abstract: Market efficiency in an ex-dividend context is still a disputed matter in the world of finance. Even though numerous articles have been published in the area, with several different approaches, this anomaly is still contested. Overall, the consensus is that the stock price falls less than the dividend amount on ex-dividend day, meaning that there is an excess return to be made at this period. In the Swedish market, previous studies are also ambiguous, with results of both efficiency and inefficiency. Because of that fact, this thesis aims to determine the level of efficiency in a Swedish mid-cap, ex-dividend setting, by implementing the methodology of Elton & Gruber (1970). Studying mid-cap listed companies provides an additional approach, since earlier studies have investigated the large- and/or small-cap. Also, the Swedish market provides a useful setting, since there is equal taxation on capital gain and dividend and a large amount of companies that pays dividend to their shareholders. In addition, we explore if investors are compensated for the inefficiency through higher returns per unit of risk, by implementing the Sharpe ratio, Treynor’s performance index and the mean-variance criterion. According to Fama & French (1993), the market is efficient if investors are compensated through higher returns for taking additional risk. Therefore, in order to determine if the market is in fact efficient, we include a variable for risk. The findings are that the market is inefficient for three of the five years studied. However, since the measure for risk, volatility, has an significant impact on the inefficiency, and the Sharpe- and Treynor’s ratios are higher for the inefficient years than the non-inefficient, the market may very well be efficient after all.