M.K.Prabhagharan Failing to diversity sufficiently Stock and Share Analyst

M.K.Prabhagharan Failing to diversity sufficiently Stock and Share Analyst

Nascent stock exchanges: Explaining success and failure

Well-developed and efficient financial markets are important contributors to the economic growth of developing economies. Unfortunately, many low- and middle-income countries lack liquid public capital markets. This column explores the performance of stock exchanges opened since 1975 across a sample of countries. A minimum number of listings and turnover in the first five years appear to be necessary conditions for success over the first two decades. Developing countries considering opening a stock exchange should ensure that there is sufficient interest from firms and investors.

Although theory is ambiguous, a large body of empirical research emphasises the importance of well-developed and efficient financial markets for economic growth, at least in developing and emerging economies (Levine 2005, Beck 2013). Many low- and even middle-income countries, however, not only have underdeveloped financial systems, but also have concentrated financial structures, dominated by banks and characterised by the absence of liquid public capital markets. While the search for an optimal mix of banks and capital markets has been so far in vain, there is evidence of an independent effect of banking sector and equity market development on economic growth (Levine and Zervos 1998, Beck and Levine 2004). This, in turn, raises the following question: What explains why some countries have well-developed equity markets while others have shallow and illiquid markets.

In a recent paper, we explore conditions for the successful establishment of public equity markets across a sample of 59 developing countries that have opened a stock exchange since 1975 (Albuquerque de Sousa et al. 2016). Specifically, we use an array of different methodologies to gauge the factors associated with the variation in success and failures of newly established stock markets. We thus complement an expansive literature that has considered cross-country variation in the development of relatively mature stock exchanges. We contribute by shedding light on the early days of new stock exchanges.

How can we measure the success of stock markets?

We can draw on substantial cross-country experience over the past 40 years in setting up new or reviving closed stock exchanges. Since 1975, the number of countries with at least one stock market has more than tripled, from 53 to 165. However, the vast majority of academic studies to date (even the ‘emerging markets’ literature) focuses on at most 50–60 of these 165 countries.

We use three measures of stock market development, widely available and used in the financial development literature:

* Market capitalisation to GDP captures the total outstanding stock at the exchanges of a country divided by real economic activity and thus proxies for the size of the stock exchange.

* Turnover ratio captures how often the average share changes hands in a given year and is an indicator of the liquidity of the stock market.

Number of firms listed on the stock exchange focuses on the diversification potential of stock exchanges, but also on the importance that the stock exchange has for the real economy.  

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