The growth of emerging equity markets (EEM) in recent years has been phenomenal. These markets comprise a growing segment of the international equity market; in terms of size (capitalization value) some markets rank among the largest in the world; in terms of performance emerging market equities have been designated an asset class for international investors. The extent to which these markets continue to provide international investors with profitable risk/return opportunities and domestic firms with a local source of equity capital depends on, inter alia, their volatility and liquidity.
Despite a series of liberalization policies in recent years, some of these markets are still characterized with structural problems. Several researchers, for example, Madura (2003) and Solnik and McLeavey (2003), have identified several obstacles to investment in EEM, they include high transaction costs resulting from illiquid markets due to low turn over ratio and high market concentration. The small number of firms listed in some markets is also viewed as potential for market failure.
Several studies have focused on analyzing the liquidity of EEM. Some, for example, Jun, Marathe and Shawky (2003), and Claessens, Dasgupta and Glen (1998) analyze the relationship between liquidity and stock returns. Others, for example, Poterba (2000), Levine (1997a), Atje and Janovic (1993), Beck and Levine (2004), Arestis et al (2001), Levine and Zervos (1998), Harris (1997), and Arestis and Demetriades (1997), analyze the relationship between stock market liquidity and economic growth. These studies find a positive relationship between liquidity and returns/economic growth. Domowitz, Glen and Madhavan (2001), using panel data for 42 countries from September 1996 to December 1998, also report that higher trading costs in emerging markets because of illiquidity; this reduces the portfolio’s returns.
These studies use two measurements of market liquidity (i) the market turnover, defined as the value of stocks traded relative to the capitalization value of market, (ii) the value of trade, defined as the value of stocks traded relative to the size of the economy (GDP). Beck and Levine (2004) identify various pitfalls in these measurements, for example, (i) value traded does not measure of the liquidity of market, it measures trading relative to the size of the economy, (ii) market capitalization which is the value of listed shares, does not suggest that listed shares will influence capital allocation and growth, and (iii) markets are forward looking and anticipate future price changes. The turnover measurement has the least definition problem. These criticisms raise concerns about validity of the results of the studies.
Download
Market Structure, Liquidity and the Performance of Emerging Equity Markets
