Ebook Market Liquidity and Stock Size Premia in Emerging Financial Markets: The Implications for Foreign Investment
Equity markets are increasingly seen as important sources of investment funds in many emerging economies. Furthermore, many countries see the development of such markets as a means to facilitate both foreign equity portfolio investment and foreign direct investment (FDI). This may occur through acquisition of shareholdings in domestic companies, which supplements the low levels of funding from domestic savings. But many emerging stock markets exhibit substantial risk premia that increases the cost of equity for listed domestic firms and deters potential foreign investors.
This paper estimates the cost of equity in four major African markets that represent the largest and most developed equity markets in Africa and which act as regional hub markets. Johannesburg dominates the Southern African Development Community (SADC), Kenya is at the centre of the East African Union, and Egypt (the Cairo and Alexandria Stock Exchanges) leads the North Africa and Maghreb region. Morocco (the Bourse de Casablanca) is included as this is the only other major equity market in North Africa. Other markets have been omitted because of their very small size and severe illiquidity. All four markets have attracted interest from international investors and multinational enterprises.
In particular, MNEs in the mining sector (for example, Anglo American, Anglo Gold, and Anglo Ashanti) and in the financial sector (such as Old Mutual, Standard Bank, Standard Chartered, Barclays, Société General, and BNP Paribas) participate in these economies. In many cases, these companies dominate the domestic markets and create a very uneven degree of liquidity. In addition, London is included as a representative of a developed market. This is especially appropriate as the London Stock Exchange and the African exchanges all fall within a +/- 2 hour time zone and London is the market on which many African firms are dual-listed.
The paper proceeds as follows. Section 2 describes the institutional characteristics of these markets, the source of the data and the construction of the illiquidity series. Section 3 provides a brief review of the literature on the Capital Asset Pricing Model (CAPM) and introduces the three-factor model of Fama and French (1993). Section 4 outlines the model to be estimated, which is based on the Fama and French (1993) model, but augmented with an illiquidity measure proposed by Amihud (2002). Section 5 discusses the construction of the data series, presents the descriptive statistics, and explains the estimation methodology. The results are in Section 6, including those for the grouped data and the individual markets. The final section concludes and offers some policy recommendations.
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