The concept of market efficiency is one with profound implications for asset returns. If studying past prices does not present opportunities for systematic excess returns to investors, then technical analysis will be an ineffective tool for asset allocation. In stronger forms of the efficient market hypothesis (EMH), full access to a company's accounts or even having private information would not lead to a systematic advantage. Asset prices fully reflect all information and are expected to be random and unpredictable. Hence, efficient stock prices are said to follow a random walk process. The objective of the research presented in this thesis is to provide a detailed characterisation of UK stock market returns. It achieves this by (i) exploring the risk factors that determine excess asset returns, (ii) analysing asset price volatilities and quantifying their relationship with a group of macroeconomic variables, and (iii) testing the efficacy of momentum strategies. There is an extensive literature conducting similar tests using US data but there is a lack of similar work using UK data. The research presented here aims to fill that gap by running extensive tests using recent data and presenting the results in a unified framework. Following a review of the recent literature, the starting point is the application of the arbitrage pricing theory (APT) and a test of its special case, the capital asset pricing model (CAPM). Methodologically, the approacl1 is the one established in the literature, i.e. running two-step regressions and forming beta-weighted portfolios. Departing from the literature, the innovations are generated from an autoregressive integrated moving average (ARIMA) model. Seven macroeconomic variables are found to be 'priced' using the APT model: real retail sales, industrial production, oil price, retail price index, money supply, long-term government bond yield and private sector bank lending. The evidence is rather damning for the CAPM. The volatilities of returns come in focus next. Appropriate generalised autoregressive conditional heteroscedastic (GARCH) procedures are applied and the relationship with the volatility of the macroeconomic variables-identified as significant in the previous chapter- is explored in the context of ordinary least squares (OLS) regressions and vector autoregressions (VAR). The market variable is found to be an important factor in these models and also in the dynamic conditional correlation (DCC) model employed separately. By using a different type of portfolio sorting method, a momentum strategy is constructed and is found to be successful in predicting future returns using past share prices. In this case, a 12-month/12-month momentum strategy is found to be the most profitable. This finding suggests that the weak-type of EMH is rejected using UK data for the period 1985-201 0. Finally, two macroeconomic variables are considered as potential determinants of momentum return and industrial production shows a significant effect.

This thesis investigates the trading on the London Stock Exchange, a multiple dealership market. It consists of four chapters. Chapter one motivates the study and summarises the major findings of the thesis. Chapter two examines the individual quoting behaviour of market makers. Quote revisions are often first made by one of the few price leaders in response to market information, and the rest follow suit. Price leaders tend to quote one side of the yellow strip to attract unbalanced orders; price followers often straddle the strip, which results in smaller but more balanced order flows. Moreover, the negative correlation between effective spreads and orders flows is detected in all but very small trades. The third chapter attempts to solve an apparent puzzle on the Exchange: market makers appear to charge different costs from different market participants. The chapter uses the theories of market microstructure to explain why the costs are different, and examines the extent to which the difference is related to the collusion of market makers or to the trading mechanisms. The evidence suggests the negotiation power of trading parties may play an important role in determining the costs of trades. The last chapter presents a new approach to estimate bid-ask spreads in multiple dealership markets. The traditional approach of estimating spreads is not applicable in those markets because observed prices cannot be ordered sequentially. An alternative method is proposed for which data sequentiality is not needed. The model is put into state space form to use the Kalman filter to estimate the fundamental price and the spread. The new method is implemented to the data of three liquid stocks on the Exchange.

The IPO market provides owners of firms and entrepreneurs with an exit for their equity investments and the opportunity to raise new capital. One empirical measure of how good a job the stock market has done for issuing firms over time is IPO underpricing. Yet, nothing is known about underpricing in Britain, nor, with one exception, about underpricing anywhere else before 1959. This thesis presents a new long-run IPO data set and analyses the change in underpricing over time. Contrary to my prior expectation and despite improvements in the regulation, disclosure, investor protection and underwriting of IPOs, underpricing rises in the second half of the century compared to the interwar years. This rise cannot be explained by any composition effect in the IPO sample or change in issue method. Plausible explanations for this puzzle include the rise of issuing house monopsonistic power, provincial competition, the exacerbation of a winner's curse and the resort to underpricing as an anti-takeover strategy in the second half of the last century. The thesis looks at the first of these possibilities and concludes that whilst reputable issuing houses appeared to neither lower nor exacerbate underpricing, they collectively failed to recommend the highly effective method of the tender offer to their corporate clients. The remaining hypotheses are to be researched in post-doctoral work. The thesis also examines how IPO underpricing and survival behaved during the two episodes of investor exuberance about technology stocks in Britain in the last century, the 1920s and 1990s. The jump in underpricing of "technology" IPOs in 1928-29 was as nothing to that witnessed in 1999-2000. On the other hand, survival of the 1999-2000 IPOs was much improved compared to the earlier period. Whilst the underpricing findings suggest that industry was not at all badly treated by the London stock market in the interwar years and was leaving small amounts of "money on the table" compared to thereafter, the survival evidence indicates the opposite to be true. A market such as that in 1928-29 where IPOs had less than a 50% chance of surviving to their fifth birthday as a quoted company was unacceptable.

This study intends to investigate the momentum effect, which states that shares which performed the best (worst) over the previous three to twelve months continue to perform well (poorly) over the subsequent three to twelve months. Evidence suggests that a strategy that buys previous winner shares and sells short past loser stocks can generate abnormal profitability of about 1 per cent per month (Jegadeesh and Titman, 1993). Although momentum payoffs tend to persist when share returns in international markets are employed (e. g., Griffin et al., 2003, Rouwenhorst, 1998), a significant number of studies have debated the potential explanation of the momentum effect without reaching a consensus. Using data from the London Stock Exchange from January 1975 to October 2001, this thesis investigates some factors that influence the magnitude of continuation gains that have not been previously identified. I examine the relationship between momentum profitability and the stock market trading mechanism and is motivated by recent changes to the trading systems that have taken place on the London Stock Exchange. Since 1975 the London stock market has employed three different trading systems: a floor based system, a computerised dealer system called SEAQ and the automated auction system SETS. I find that after the introduction of the computerised dealer system SEAQ momentum profits are higher than when the floor based system operated. I also document that companies trading on the SETS auction system display greater momentum profitability than shares trading on SEAQ. Results are robust to the use of different samples and alternative risk adjustments. I investigate the role of volatility in influencing momentum profits. Shares with high volatility display wide spread out returns and therefore, potential higher magnitude momentum profitability. Given that shares displayed higher volatility traded on the post-Big Bang period (Tonks and Webb, 1991) and on the SETS system (Chelley-Steeley, 2003), I examine whether the different levels of momentum profitability achieved in alternative stock market structures arises from volatility. I find that momentum profits are strongly influenced by volatility, but the finding that the organisation of a stock market influences the momentum profits holds even after considering differences in volatility. I examine whether the magnitude of momentum profitability varies following bull and bear markets. Momentum profits stem from the winner shares in bull markets and from the loser stocks in bear markets. I report that momentum profits are stronger following bear markets, showing a sign of mean reversion in the UK stock market. Overall, this study contradicts the model of Hong and Stein (1999) that the momentum effect arises from the gradual expansion of information among investors and the model of Daniel et al, (1998) that the momentum effect stems from the investors' overconfidence that increases following the arrival of confirming news. This study also indicates that a significant portion of momentum profits stem from the magnitude of volatility.