EFFICIENCY OF THE TAIWAN STOCK MARKET* By JAMES J. KUNG† and WING-KEUNG WONG‡ †Ming Chuan University ‡National University of Singapore This study uses two popular technical trading rules to assess whether the gradual liber- alization of Taiwan’s securities markets has improved the efficiency of its stock market. The results show that the two rules have considerable predictive power for 1983–1990, they become less predictive for 1991–1997, and they cannot predict the market for 1998–2005. These results indicate that the efficiency of Taiwan stock market has been greatly enhanced by the liberalization measures implemented over the last 20 years. JEL Classification Numbers: G12, G14. 1. Introduction On 12 May 2005, Morgan Stanley Capital International (MSCI) adjusted its Limited Investability Factor or LIF 1 on Taiwan stock index from 0.75 to 1.00. In addition, MSCI’s weighting of Taiwan equities in its Emerging Market Index was also adjusted upward from 13.07% to 16.87%, making Taiwan second among the world’s emerging market countries, just behind Korea’s 17.15%. These adjustments represented MSCI’s endorse- ment of the financial market reforms made by Taiwan’s Securities and Futures Commis- sion (SFC) over the last 20 years. One major reform of the SFC was the abolishment of the Qualified Foreign Institutional Investor (QFII) system in 2003. Over the years, one of the SFC’s policy directives has been “to improve the operation of the securities and futures markets and to ensure a fair and efficient market environ- ment”. As the SFC once pointed out, increased foreign participation will make the securities markets “even more liquid, deep, and diversified”. Hence, the aim of this study is to investigate whether or not the gradual liberalization of Taiwan’s securities markets has improved the efficiency of its stock market. 2 Specifically, we divide the sample period into three subperiods and examine if market efficiency has been enhanced as we move forward through the three subperiods. To implement this, we use two simple but popular technical trading rules—moving average and trading range break—to assess the efficiency of Taiwan’s stock market. The rationale for using them is that if the market is efficient, it is not possible to make abnormal returns with these trading rules. These two rules were used by many researchers * We would like to thankAndrew P. Carverhill of the University of Hong Kong, K. C. Chan, Kalok Chan and John K. Wei of the Hong Kong University of Science andTechnology for constructive comments. We are grateful to the coeditor of JER for some very valuable suggestions. Remaining errors are our own. 1 A market with an LIF of 1.00 means that MSCI allots the market full weight in its various MSCI indices. For example, at the end of 2004,Taiwan’s market capitalization was around NTr14,000 billion (USr430 billion). An LIF of 0.75 would mean an adjusted capitalization of NTr10,500 billion (USr320 billion), not NTr14,000 billion, was used to compute MSCI’s Emerging Markets Free Index. 2 Bailey et al. (1990) and Pan et al. (1991) found evidence that prices in Taiwan’s stock market before the 1990s displayed substantial deviations from random walk behaviour. The Japanese Economic Review doi: 10.1111/j.1468-5876.2008.00448.x Vol. 60, No. 3, September 2009 389 © 2008 The Authors Journal compilation © 2008 Japanese Economic Association