The Dynamics of Emerging Stock Markets: Empirical Assessments and Implications

213 Pages·2010·1.832 MB·English

by  Mohamed El Hedi Arouri, Fredj Jawadi, Duc Khuong Nguyen (auth.)

Contributions to Management Science
Forfurther volumes:
http://www.springer.com/series/1505
Mohamed El Hedi Arouri Fredj Jawadi
l l
Duc Khuong Nguyen
The Dynamics of Emerging
Stock Markets
Empirical Assessments and Implications
Prof.MohamedElHediArouri Prof.FredjJawadi
UniversityofOrleans AmiensSchoolofManagement
FacultyofLaw,Economics, 18placeSaintMichel
andManagement 80000AmiensCX
ruedeBlois France
45067Orle´ansCX02 [email protected]
France
[email protected]
Prof.DucKhuongNguyen
ISCParisSchoolofManagement
22BoulevardduFortdeVaux
75848ParisCX17
France
[email protected]
ISSN:1431-1941
ISBN:978-3-7908-2388-2 e-ISBN:978-3-7908-2389-9
DOI10.1007/978-3-7908-2389-9
SpringerHeidelbergDordrechtLondonNewYork
LibraryofCongressControlNumber:2009936784
#Springer-VerlagBerlinHeidelberg2010
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Preface
Bytheendof2008,thirty-fourdevelopingcountrieswereconsideredas“emerging
markets”bytheworld’sleadingindexproviderStandardandPoor’saccordingtoa
wide range of economic and financial criteria. Yet, the more we learn about the
financial markets in developed countries, the more challenging and mysterious
emergingmarketslook.
Thirty years ago, they, the 32 emerging markets surveyed by the International
Finance Corporation in 1982, started to attract attention from investors of devel-
opedcountries. Thesimplereason is thatexposure toemergingmarketsallows to
take advantage of their enormous growth potential which generates distinctively
equityreturnssuperiortothoseondevelopedmarkets.Moreover,asfarasdiversi-
fication issues are concerned, adding emerging market assets into an existing
portfolio would lead to improving its risk-adjusted return performance as they
have a low correlation with developed markets. The increased investor interest
for investing in emerging markets is also linked to the wave of market reform
policies aiming to stimulate economic growth, weakened by severe recession and
oil crisis of the early 1970. As foreign investors benefit from a greater access to
local markets following their openings, private capital flows (net foreign direct
investment,portfolioinvestment,andbankloansanddeposits)toemergingmarkets
have steadily increased over time, from only $39.8 billion in 1990 to $1974.9
billionin2007.
Emerging markets, however, encounter several periods of reversals of foreign
capital flows. The 1980s was particularly marked by the debt crisis in Latin
Americawhilethe1990switnessedmanyepisodesofextremeinstabilityincluding,
amongothers,theMexicanpesodevaluationin1994–1995andAsianandRussian
crises in 1997 and 1998. Some would attribute these consequences to increased
mobilityofcross-bordercapitalsresultingfromfinancialliberalization.
These observations raise some intriguing questions relating to both market
participants (foreign and domestic) and policymakers of emerging markets, and
themostimportantare:
v
vi Preface
– Whatarethediversificationbenefitsfrominvestinginemergingmarkets?And
totheextentthatemergingmarketshavebecomemoreintegratedintotheworld
financial system in recent years, how strong will be these benefits in the
longrun?
– Is the long-term performance of emerging markets sustainable, given their
relativevulnerabilitytoexternalshocks?
– What are, for policymakers wishing to know the effectiveness of their reform
programs, the effects of increased foreign participation in domestic financial
marketsandrealeconomy?
Answering such questionsrequiresnotonly agood understanding ofemerging
markets and the underlying factors of their dynamics, but also an appropriate
analysis tools because standard models proposed in financial theory often fail to
dealwithspecificcharacteristicsinherenttothesemarkets.
By blending both theoretical and empirical approaches, this book attempts to
bridgethegapbetweentheoriesandpracticesofemergingmarkets,usingmodern
financial econometric techniques. The text is structured in three parts. Part I,
composed of two chapters, provides a comprehensive overview ofemerging mar-
kets in terms of their accessibility, performance characteristics, and dynamics
related to ongoing market reforms. Part II, composed of four chapters, explores
the dynamicsofasset prices andvaluations inemergingmarketswith aparticular
focusonassetpricing,evolvingefficiencyandreturnvolatility.PartIII,composed
ofthreechapters,developsspecificmodelstoapprehendthedynamicsofemerging
marketintegrationwith theworldmarketsaswellascontagioneffectsaroundthe
currentglobalfinancialcrisis2007–2008.
We hope that readers will find material in “The Dynamics of Emerging Stock
Markets”,relevantandusefulforunderstandingtheevolvingbehaviorofemerging
marketsinthecontemporaryinternationalfinancialarchitecture.
M.E.H.Arouri,F.Jawadi,andD.K.Nguyen
Acknowledgements
We would like to acknowledge with considerable appreciation those who have
directlyorindirectlycontributedtothepublicationofthisbook.
Ourthanksgoparticularlytoallourcolleagueswhoprovideduswithconstruc-
tiveandhelpfulcommentsduringinternationalconferencesandseminars.
We are also very grateful to our family members for their full support and
encouragementsthroughoutthewritingofthisbook.
vii
Authors
Dr.MohamedElHediArouriisanassociateprofessorofFinanceattheUniversity
of Orleans and a Researcher at EDHEC Business School (France). He holds a
Master’sdegreeinEconomicsandaPhDinFinancefromtheUniversityofParisX
Nanterre.Hisresearchfocusesonthecostofcapital,stockmarketintegration,and
international portfolio choice. He published articles in refereed journals such as
International Journal of Business and Finance Research, Frontiers of Finance and
Economics,AnnalsofEconomicsandStatistics,andFinance.
Dr. Fredj Jawadi is currently an assistant professor at Amiens School of
Management and a Researcher at EconomiX at the University of Paris Ouest
Nanterre La Defense (France). He holds a Master in Econometrics and a PhD in
financialeconometricsfromtheUniversityofParisXNanterre.Hisresearchtopics
cover modelling asset price dynamics, nonlinear econometrics, international
finance and financial integration. He has published articles in refereed journals
suchasJournalofRiskandInsurance,AppliedFinancialEconomics,Finance,and
EconomicsBulletin.
Dr. Duc Khuong Nguyen is an associate professor of Finance and Head of the
Department of Economics, Finance and Law at ISC Paris School of Management
(France).HeholdsanMScandaPhDinFinancefromtheUniversityofGrenobleII
(France). His principal research areas concern emerging markets finance, market
efficiency,volatilitymodeling,andriskmanagement.Hehaspublishedarticlesin
refereedjournalssuchasReviewofAccountingandFinance,ManagerialFinance,
American Journal of Finance and Accounting, Economics Bulletin, Applied Eco-
nomicsLetters,andBankers,MarketsandInvestors.
The courses taught by the authors in their respective institutions cover a wide
range of topics including, among others, international finance, portfolio manage-
ment,financialeconometrics,andfinancialmarketsandvaluations.
ix
Contents
1 EmergingMarkets:OverviewandPerformanceAnalysis ...........1
1.1 BasicsofEmergingMarkets ................................1
1.1.1 TheConceptofEmergingMarkets .......................2
1.1.2 DispersionsAmongEmergingMarkets....................3
1.1.3 CapitalMarkets......................................5
1.2 RiskandReturnCharacteristicsofEmergingStockMarkets ....... 11
1.2.1 RiskandReturns....................................12
1.2.2 Correlation ........................................14
1.3 TheProcessofMarketIntegrationandRisk-returnTradeoff ....... 16
1.3.1 TheCaseofCompleteIntegration.......................16
1.3.2 TheCaseofPartialMarketIntegration ...................17
1.4 SpecificRisks .......................................... 18
1.4.1 PoliticalRisk ......................................18
1.4.2 LiquidityRisk......................................19
1.4.3 CurrencyRisk......................................19
1.5 InvestinginEmergingMarkets:WhyandHow? ................ 20
1.5.1 AdvantagesofEmergingMarkets.......................20
1.5.2 AccessibilitytoForeignInvestors.......................22
1.5.3 MarketEntryMethods ...............................23
1.5.4 TheFutureofEmergingMarketInvestments...............24
1.6 Summary.............................................. 26
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2 DynamicProcessofFinancialReforms .........................29
2.1 OilShocksandEconomicRecessioninthe1970s ............... 29
2.2 FinancialLiberalizationasaSolutiontoEconomicDevelopment.... 30
2.3 LiberalizationMethodsandIndicators........................ 31
2.3.1 OfficialVersusEffectiveLiberalizations..................31
2.3.2 LiberalizationIndicators..............................32
2.4 DynamicsofLiberalizationProcess.......................... 39
2.4.1 TheGradualProcessofFinancialLiberalization............39
xi
xii Contents
2.4.2 TheIntensityofLiberalization .........................40
2.4.3 ChallengesinMeasuringLiberalizationEffects.............43
2.5 FinancialImpactsofLiberalization .......................... 44
2.5.1 CostofCapital .....................................45
2.5.2 ObservedVolatility..................................47
2.5.3 UnconditionalCross-MarketCorrelation..................50
2.5.4 StockMarketDevelopment............................53
2.6 Summary.............................................. 53
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
3 AssetPricingModels........................................55
3.1 Introduction............................................ 55
3.2 TheCapitalAssetPricingModel............................ 56
3.2.1 TheoreticalFrameworkoftheModel ....................56
3.2.2 TheCAPM........................................58
3.2.3 ExtensionsoftheOriginalModel .......................60
3.2.4 EmpiricalTestoftheCAPM...........................62
3.3 ArbitragePricingTheory.................................. 64
3.3.1 TheoreticalFrameworkoftheModel ....................64
3.3.2 DerivationoftheValuationRelationship..................66
3.3.3 APTandCAPM ....................................67
3.3.4 ExtensionsoftheAPT:TowardstheEquilibriumAPT .......68
3.3.5 EmpiricalTestoftheAPT ............................68
3.4 ParticularitiesofAssetPricinginEmergingMarkets ............. 69
3.5 Summary.............................................. 70
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
4 ThresholdStockPriceAdjustments............................73
4.1 Introduction............................................ 73
4.2 EconomicJustificationsofNonlinearityin
StockPriceDynamics .................................... 74
4.2.1 MarketMicrostructureApproach........................74
4.2.2 BehavioralFinanceApproach..........................75
4.2.3 NonlinearityandEmergingStockMarkets ................76
4.3 ThresholdEconometricModeling ........................... 78
4.3.1 BriefPresentationofThresholdModels ..................78
4.3.2 MixingTests.......................................80
4.4 EmpiricalResultsandDiscussions........................... 81
4.4.1 DataandPreliminaryTests............................81
4.4.2 MixingTestResults .................................82
4.4.3 EstimationofESTECMs..............................82
4.4.4 EssaysinNonlinearModelingofOilandStockMarket
Linkages..........................................85
4.5 Summary.............................................. 88
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Contents xiii
5 EvolvingStockMarketEfficiency .............................91
5.1 TheoryofStockMarketEfficiency .......................... 91
5.1.1 TheConcept.......................................92
5.1.2 ConsequencesoftheMarketEfficiency...................93
5.1.3 ThreeFormsofInformationalEfficiency..................95
5.1.4 EmpiricalEvidence..................................96
5.1.5 AnomaliestoMarketEfficiency ........................97
5.2 InformationalEfficiencyinEmergingStockMarkets............. 98
5.2.1 ChallengestoMarketEfficiency........................99
5.2.2 UsualTestsandEvidenceonMarketEfficiency ...........101
5.2.3 FinancialLiberalizationandMarketEfficiency............103
5.3 StructuralReformsandHypothesisofEvolvingEfficiency ....... 105
5.3.1 RationaleoftheEvolvingEfficiency....................105
5.3.2 EconometricSpecification............................106
5.3.3 WeakFormEfficiencyandTransactionCosts.............108
5.4 ResultsandDiscussions.................................. 109
5.4.1 SummaryStatistics.................................109
5.4.2 TheEvidenceofTime-VaryingPredictability.............110
5.4.3 TheEffectofFinancialLiberalization...................115
5.5 ImplicationsoftheResults................................ 119
5.6 Summary............................................. 119
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119
6 StockMarketVolatility ....................................123
6.1 Introduction........................................... 123
6.2 FinancialRiskandItsAssessment.......................... 124
6.2.1 EmpiricalApproach ................................124
6.2.2 ProbabilisticApproach ..............................125
6.3 BehaviorandSourcesofEmergingMarketVolatility............ 126
6.4 Time-VaryingVolatilityModels ........................... 127
6.4.1 LinearARCHModels...............................128
6.4.2 NonlinearARCHModels ............................130
6.4.3 ARCH-MModels..................................131
6.4.4 VolatilityModelingandTests.........................132
6.4.5 EmpiricalEvidenceonEmergingMarketVolatility
UsingGARCHModelingApproach ....................133
6.5 EmpiricalApplicationsofGARCHModeling ................. 134
6.5.1 DataandPreliminaryAnalysis ........................134
6.5.2 GARCH-BasedModelsforEmergingMarketVolatility .....137
6.6 Summary............................................. 142
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143
7 GlobalizationandMarketIntegration.........................145
7.1 Introduction........................................... 145