How Have the Emerging Stock Exchanges in Africa Responded to Market Reforms?

Abstract

In this paper, we focus on how the stock markets in Africa have responded to the reform process. We identify three main types of reforms implemented in these markets since the 1990s, namely revitalization of the regulatory framework, modernization of trading systems, and relaxation of restrictions on foreign investors. We invoke market microstructure theory to hypothesize the expected response of the markets in terms of efficiency and volatility to the three types of reforms. Econometric methods are applied to test the hypotheses on a sample of ten stock exchanges, for the period 1988:01-1999:12. The evidence generally suggests that there are benefits of investments to improve market microstructure. For example, a comparative analysis across the sample demonstrates that markets with advanced trading technology, tight regulatory system and relaxed foreign investors' participation show greater efficiency and lower market volatility. Although direction of causality between efficiency and volatility varies across the markets, in general, we infer that reforms, which reduce volatility, reap higher efficiency. However, in some markets, the effects of the reforms are too recent to show any clear response pattern.     

International capital flows,returns and world financial integration

International capital flows have increased dramatically since the 1980s, with much of the increase being due to trade in equity and bond markets. Such developments are often attributed to the increased integration of world financial markets. We present a model that allows us to examine how greater integration in world financial markets affects the behavior of international capital flows and financial returns. Our model predicts that international capital flows are large (in absolute value) and very volatile during the early stages of financial integration when international asset trading is concentrated in bonds. As integration progresses and households gain access to world equity markets, the size and volatility of international bond flows decline. This is the natural outcome of greater risk sharing facilitated by increased integration. This pattern is consistent with declining volatility observed during 1975–2007 period in the G-7 countries. We also find that the equilibrium flows in bonds and stocks predicted by the model are larger than their empirical counterparts, and are largely driven by variations in equity risk premia. The model also predicts that volatility of equity and bond returns decline with integration, again consistent with the data for G-7 economies.     

Impact of terrorist attacks on stock market volatility in emerging markets

We use an event study methodology alongside an improved bootstrapping test to evaluate the impact of terrorist attacks on the volatility of stock markets in 12 MENA countries, and test for regional financial integration. Results show that the impact of terrorist attacks on financial markets' volatility lasts about 20 trading days, which is considered to be long compared to the term effect of similar events in developed markets. Moreover, we find evidence of regional financial integration. Our robustness check shows that the bootstrapping approach is more robust, and that theoretical p-values might be misleading if underlying assumptions are violated.     

Volatility,global information,and market conditions: a study in futures markets

This study examined the behavior of return volatility in relation to the timing of information flow under different market conditions influenced by trading volume and market depth. We emphasized information flow during trading and nontrading periods that may represent domestic and offshore information in the global trading of currencies. Test results show that volatility was negatively related to market depth; that is, deeper markets had relatively less return volatility. Additionally, the effect that market depth had on volatility was superseded by information within trading volume. Test results focusing on the timing of information flow reveal that in low‐volume markets, the volatility of nontrading‐period returns exceeded the volatility of trading‐period returns. However, when trading volume was high, this pattern was reversed and conformed to the observations of earlier articles. Our findings proved to be robust across time, different currency markets, and different measures of return volatility. We also observed a trend toward greater integration between foreign and U.S. financial markets; the U.S. market increasingly emphasized information from nontrading periods to supplement information arriving during trading periods. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:173–196, 2001     

Trade, offshoring, and the invisible handshake

We study the effect of globalization on the volatility of wages and worker welfare in a model in which risk is allocated through long-run employment relationships (the ‘invisible handshake’). Globalization can take two forms: international integration of commodity markets (i.e., free trade) and international integration of factor markets (i.e., offshoring). In a two-country, two-good, two-factor model we show that free trade and offshoring have opposite effects on rich-country workers. Free trade hurts rich-country workers, while reducing the volatility of their wages; by contrast, offshoring benefits them, while raising the volatility of their wages. We thus formalize, but also sharply circumscribe, a common critique of globalization.     

Global Volatility and Forex Returns in East Asia*

During 2001–2010, increases in mature market volatility were associated with declines in forex returns for East Asian economies, consistent with an overall ‘flight to safety’ effect. Estimates from GARCH models suggest that a 10 percentage point increase in mature market equity volatility generated an exchange rate depreciation of up to 3/4 percent. This sensitivity rose during a more tranquil subsample for some countries, reflecting their greater integration with global financial markets. Long‐run forex volatility increased in Asian economies after 2008, reflecting the global reach of the financial crisis in mature markets. Unconditional standard deviations estimated from these models provide operational measures of ‘long‐term’ and ‘excess’ volatility in forex markets.     

Informed options trading on the implied volatility surface: A cross-sectional approach

This study investigates the cross-sectional implication of informed options trading across different strikes and maturities. We explore the term structure perspective of the one-way information transmission from options markets to stock markets by adopting well-known option-implied volatility measures to examine stock return predictability. Using equity options data for U.S. listed stocks spanning 2000–2013, we find that the shape of the long-term implied volatility curve exhibits extra predictive power for stock returns of subsequent months even after orthogonalizing the short-term components. Our findings indicate that the inter-market information asymmetry rapidly disappears before the expiration of long-term option contracts.     

Looking for contagion in currency futures markets

This article tests whether there are pure contagion effects in both conditional means and volatilities among British pound, Canadian dollar, Deutsche mark, and Swiss franc futures markets during the 1992 ERM crisis. A conditional version of international capital asset pricing model (ICAPM) in the absence of purchasing power parity (PPP) is used to control for economic fundamentals. The empirical results indicate that overall there are no mean spillovers among those futures markets, but they are detected during the crisis period. That is, past return shocks originating in any one of the four markets have no impact on the other three markets during the entire sample period, suggesting that these markets are weak‐form efficient. However, this weak‐form market efficiency fails to hold during the market turmoil, especially for British pound and Swiss franc, and the sources of contagion‐in‐mean effects are mainly due to the return shocks originating in three European currency futures markets. As for the contagion‐in‐volatility, it is detected for British pound only because its conditional volatility is influenced by the negative volatility shocks from Canadian dollar, Deutsche mark, and Swiss franc, with Deutsche mark playing the dominant role in generating these shocks. JEL Classifications: C32; F31; G12. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:957–988, 2003     

Indian equity options: Smile,risk premiums,and efficiency

We study the pricing of equity options in India which is one of the world's largest options markets. Our findings are supportive of market efficiency: A parsimonious smile-adjusted Black model fits option prices well, and the implied volatility (IV) has incremental predictive power for future volatility. However, the risk premium embedded in IV for Single Stock Options appears to be higher than in other markets. The study suggests that even a very liquid market with substantial participation of global institutional investors can have structural features that lead to systematic departures from the behavior of a fully rational market while being “microefficient.”     

Volatility spillover and hedging effectiveness among China and emerging Asian Islamic equity indexes

We study the volatility spillover between China and Asian Islamic stock markets. We use a sample of six Islamic MSCI indices from the Asian region, namely China, India, Malaysia, Indonesia, Korea and Thailand obtained from MSCI (Morgan Stanley Capital International). In this paper we analyze the importance of considering spillover effects between emerging Asian Islamic indexes based on the Bivariate VARMA-BEKK-AGARCH model of McAleer et al. (2009), which includes spillover and asymmetric effects. We compute after the effectiveness of portfolio diversification based on the conditional volatility of returns series. Results show a significant positive and negative return spillover from China to selected Asian Islamic stock market and bidirectional volatility spillovers between China, Korea and Thailand Islamic market showing evidence of short-term predictability on Islamic Chinese stock market movements. However there is no short term volatility persistence in India, Indonesia and Malaysia. GARCH results show no persistence in volatility spillover effect in long term from Chinese to Indian, Indonesian and Korean Islamic stock market. Our findings are beneficial for international portfolio diversification for policy makers and investors since the results of portfolio management and hedging effectiveness ratio are different to previous studies.     

Speculation and volatility—A time-varying approach applied on Chinese commodity futures markets

Experts have long discussed and empirically investigated whether speculative activity increases volatility on commodity futures markets. Little empirical research, however, analyzes the role of speculators on commodity futures markets in China. Using time-varying vector autoregression models with stochastic volatility, this paper investigates for four heavily traded metal and agricultural contracts, how the relationship between returns volatility and speculation evolves over time. Our findings indicate that speculative activity has little to no impact on volatility. On the contrary, for all commodities examined, returns volatility seems to amplify speculation.     

Idiosyncratic volatility and mergers and acquisitions in emerging markets

Given the recent findings in the literature that idiosyncratic volatility reflects stock price informativeness, we analyze the impact of idiosyncratic volatility on many acquisition parameters. We find that idiosyncratic volatility is positively related to acquisition premium; the relationship is more significant in deals that occurred in information-poor economies where acquirers have difficulty gathering information about the targets. These deals typically involve bidders from emerging markets and those that have less experience in the target country. Idiosyncratic volatility is also positively related to acquisition completion rate, the likelihood of the bidder acquiring majority control, but is negatively related to takeover probability.     

Liquidity and stock returns in emerging equity markets

Using data for 27 emerging equity markets for the period January 1992 through December 1999, we document the behavior of liquidity in emerging markets. We find that stock returns in emerging countries are positively correlated with aggregate market liquidity as measured by turnover ratio, trading value and the turnover–volatility multiple. The results hold in both cross-sectional and time-series analyses, and are quite robust even after we control for world market beta, market capitalization and price-to-book ratio. The positive correlation between stock returns and market liquidity in a time-series analysis is consistent with the findings in developed markets. However, the positive correlation in a cross-sectional analysis appears to be at odds with market microstructure theory that has been empirically supported by studies on developed markets. Our findings regarding the cross-sectional relation between stock returns and liquidity is consistent with the view that emerging equity markets have a lower degree of integration with the global economy.     

The fear of globalizing capital markets

It is generally accepted that free flow of goods benefits both economies without serious risks. The situation with the free flow of capital is different. Many policy makers and economists are skeptical not only about the benefits of free flow of capital, but also see uncontrolled capital flows as risky and destabilizing. Other economists, however, firmly believe that free capital flows will lead to a more efficient allocation of resources and greater economic growth. Nevertheless, the debate has little empirical evidence to rely on. We hope to fill that gap in this paper. We study the benefits and risks associated with capital flows by examining the experience of emerging economies around the time that foreign investment in stock markets was allowed. We investigate the impact of capital flows on stock returns, stock market efficiency, inflation, and exchange rates. We also examine the effect on different kinds of volatility that might arise as a consequence of capital flows: volatility of stock returns, volatility of inflation rates, and volatility of exchange rates. We find no evidence of an increase in inflation or an appreciation of exchange rates. Stock returns reflect a lower cost of capital after liberalization. There is no increase in stock market volatility and the volatility of inflation and exchange rates actually decreases. Stock markets become more efficient as determined by testing the random walk hypothesis.     

The volatility effect in emerging markets

We examine the empirical relation between risk and return in emerging equity markets and find that this relation is flat, or even negative. This is inconsistent with theoretical models such as the CAPM, which predict a positive relation, but consistent with the results of studies for developed equity markets. The volatility effect appears to be growing stronger over time, which we argue might be related to the increased delegated portfolio management in emerging markets. Finally, we find that the volatility effect in emerging markets is only weakly related to that in developed equity markets, which argues against a common-factor explanation.     

Understanding bilateral exchange rate volatility

This paper develops an empirical model of bilateral exchange rate volatility. We conjecture that for developing economies, external financial liabilities have an important effect on desired bilateral exchange rate volatility, above and beyond the standard optimal currency area (OCA) factors. By contrast, industrial countries do not face the same set of constraints in international financial markets. In our theoretical model, external debt tightens financial constraints and reduces the efficiency of the exchange rate in responding to external shocks. We go on to explore the determinants of bilateral exchange rate volatility in a broad cross section of countries. For developing economies, bilateral exchange rate volatility (relative to creditor countries) is strongly negatively affected by the stock of external debt. For industrial countries however, OCA variables appear more important and external debt is generally not significant in explaining bilateral exchange rate volatility.     

Volatility spillover effects and cross hedging in corn and crude oil futures

Using a volatility spillover model, we find evidence of significant spillovers from crude oil prices to corn cash and futures prices, and that these spillover effects are time‐varying. Results reveal that corn markets have become much more connected to crude oil markets after the introduction of the Energy Policy Act of 2005. Furthermore, when the ethanol–gasoline consumption ratio exceeds a critical level, crude oil prices transmit positive volatility spillovers into corn prices and movements in corn prices are more energy‐driven. Based on this strong volatility link between crude oil and corn prices, a new cross‐hedging strategy for managing corn price risk using oil futures is examined and its performance is studied. Results show that this cross‐hedging strategy provides only slightly better hedging performance compared with traditional hedging in corn futures markets alone. The implication is that hedging corn price risk in corn futures markets alone can still provide relatively satisfactory performance in the biofuel era. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

Stock index futures markets: stochastic volatility models and smiles

This study examined whether the inclusion of an appropriate stochastic volatility that captures key distributional and volatility facets of stock index futures is sufficient to explain implied volatility smiles for options on these markets. I considered two variants of stochastic volatility models related to Heston (1993). These models are differentiated by alternative normal or nonnormal processes driving log‐price increments. For four stock index futures markets examined, models including a negatively correlated stochastic volatility process with nonnormal price innovations performed best within the total sample period and for subperiods. Using these optimal stochastic volatility models, I determined the prices of European options. When comparing simulated and actual options prices for these markets, I found substantial differences. This suggests that the inclusion of a stochastic volatility process consistent with the objective process alone is insufficient to explain the existence of smiles. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:43–78, 2001     

Emerging Equity Market Volatility

Abstract

This paper considers two emerging markets that are under-researched, Kenya and Nigeria. It offers a comprehensive view of four time properties that emerged from the empirical time series literature on asset returns: (1) the predictability of returns from past observations; (2) the auto-regressive behavior of conditional volatility; (3) the asymmetric response of conditional volatility to innovations; and (4) the conditional variance risk premium. Results of the exponential GARCH (EGARCH) model indicate that asymmetric volatility found in the U.S. and other developed markets also characterized the Nigerian stock exchange. In Kenya, however, the asymmetric volatility coefficient is significant and positive, suggesting that positive shocks increase volatility more than negative shocks of an equal magnitude. The Nairobi Stock Exchange (KSE) returns series report negative but insignificant risk-premium parameters. In Nigeria (NSE), return series exhibit a significant and positive time-varying risk premium. The results also show that expected returns are predictable, that the auto-regressive return parameters (? ₁ ) are significant in both Kenya and Nigeria. Finally, the GARCH parameter (b) is statistically significant, indicating that volatility persistence is present in the two emerging markets studied.     

Foreign investment,regulation and price volatility in South-east Asian stock markets

This paper examines the extent to which changes in the openness of three South-east Asian Stock Markets to foreign investors impact on the volatility of prices in those markets. Regulatory authorities have been cautious about the opening up of markets to foreign investors, fearing that increased liberalisation may lead to increased price volatility, which, in turn, may have a detrimental effect on the operation of the market and the wider economy. Using an asymmetric GARCH model, it is shown that while greater liberalisation has changed the nature of price volatility in the markets, there has not been a destabilising impact. Rather, asymmetric responses of volatility to news have reduced post-liberalisation, suggesting that informed traders are playing a greater role in the markets, with the impact of noise traders being reduced.