Up to the early 1990s, real wages in the U.S. and in Europe were considered to be almost noncyclical by macroeconomists who derived this evidence from analyses of aggregate time series. However, the use of longitudinal microdata allows researchers to follow the same workers over time, and more recent micro-based studies showed that wages in fact react to recessions and expansions in a procyclical way. Solon, Barsky, and Parker (1994) attribute the phenomenon that real wages at an aggregate level barely show any cyclicality to composition effects.
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.
Using a unique and comprehensive dataset containing the detailed cash-flows generated by 4,403 liquidated private equity investments, we show that innovations in aggregate liquidity are a major driver of private equity returns. The investments held during the worst liquidity conditions defined as the bottom decile of Pastor and Stambaugh’s (2003) innovations in aggregate liquidity have an average annual return of -12%. At the opposite end, investments held during the best liquidity conditions have an average return of 31% (see Figure 1). This result also holds in regression analysis and is robust to the inclusion of a number of control variables.
To our knowledge, this is the first study to test and document the role played by liquidity risk in the cross-section of private equity returns. The literature has focused on drivers of returns across funds (e.g., Kaplan and Schoar (2005)). Having returns that are disaggregated at the investment level provides us with a unique opportunity to measure the influence on private equity performance of macro-economic conditions, including aggregate liquidity.
