In recent years, venture capital (VC) investments across national borders have started to trend upwards. Foreign or cross-border investment in venture capital markets has increased from 10% of all venture capital investments in 1991 to 22.7% in 2008 (based on number of venture capital investments). An important driver of this increase is the significant upward trend in international venture capital investments in emerging nations over this time period. The number of venture capital investments by international investors as a fraction of total venture capital investments in emerging nations increased from 8.7% in 1991 to 56% in 2008.
In the 1990s, currency crises in Europe, Mexico and Southeast Asia have drawn worldwide attention to speculative attacks on government-controlled exchange rates. To improve understanding of these events, research has proceeded on both theoretical and empirical fronts.
The purpose of this paper is to provide some perspective on this research and to relate it to earlier work in the area. The early work, now called first-generation research, responded to currency crises in developing countries such as Mexico (1973-1982) and Argentina (1978-81). These crises were preceded by overly expansive domestic policies. First-generation models show how a fixed exchange-rate policy combined with excessively expansionary pre-crisis fundamentals push the economy into crisis, with the private sector trying to profit from dismantling the inconsistent policies.
Emerging stock markets have been the subject of a large body of research in the literature on international asset pricing. In this paper, we analyse two main issues regarding the development of emerging stock markets’ financial integration levels over the last decade. The first objective is to estimate the level of financial integration of these stock markets, by developing and testing a three factor asset pricing model, in the spirit of Chen et al. (1986). The asset pricing model assumes that emerging stock markets excess returns are driven by a world stock market factor, a domestic stock market factor and a systematic emerging stock market factor. It allows us to investigate whether the level of stock market integration of a sample of 25 emerging market countries has been affected by the various financial crises of the 90’s. The main characteristic of this model is that it analyzes stock market integration and its time-series behavior while simultaneously accounting for the pricing of “systematic emerging market risk” by foreign investors. Indeed, we conjecture that by investing even in a diversified portfolio of those countries’ stocks, an investor will not be able to completely abstract from the economic instability prevailing in emerging markets. Hence, we introduce in our asset pricing model, a new factor, defined as the systematic emerging market risk proxy and account for the fact that investors may require higher expected excess returns to bear the economic instability inherent to a diversified portfolio of emerging markets’ stocks. Our proxy for systematic emerging market risk is the difference between the yield of the J.P. Morgan EMBI global index and the ten-year US Treasury bond yield.
The empirical results are obtained by studying a sample of 25 emerging stock markets countries over the period January, 1st 1995 to June 30th, 2004. To our knowledge, there is in the literature only one other study by DeJong and DeRoon (2005) that covers such an extensive range of emerging markets. The results suggest that these countries still remain, to a large extent, segmented and that the level of integration,especially in Asian countries, has decreased following the various financial crises of the late 1990s. More recently, the level of stock market integration of several countries has been trending upwards but has also become more volatile. Moreover, the systematic emerging market risk exposure is significant for all countries in the sample and commands a time varying risk premium.
