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Market liquidity and stock size premia in emerging financial markets: The implications for foreign investment

Market liquidity and stock size premia in emerging financial markets: The implications for foreign investment
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: South Africa, Kenya, Egypt and Morocco. These represent the largest and most developed equity markets in Africa and also act as regional hub markets. London is also included as a link between the emerging and developed financial markets. The Fama and French [Fama, E., & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3-56] three-factor model capital asset pricing model is augmented to take account of company size and illiquidity factors that feature in African financial markets. The results show that the premia associated with size are more prevalent than with liquidity although both are highly significant in both valuation and cost of equity estimates. The evidence suggests that the lowest cost of equity is achieved in the two major international markets of London and Johannesburg, while the less-advanced North African markets of Morocco and Egypt have higher costs of equity. The developing Kenyan market has the highest cost of equity, although the costs associated with the main market are less than one-third of that in the Alternative Investment Market.

Africa, Capital asset pricing model, Emerging financial markets, Liquidity
0969-5931
489-501
Hearn, Bruce
45dccea3-9631-4e5e-914c-385896674dc2
Piesse, Jenifer
b85393d2-b4ae-49f2-87cd-8b5007c99e97
Strange, Roger
6f7b0a47-0014-4242-ad02-f3476a75322f
Hearn, Bruce
45dccea3-9631-4e5e-914c-385896674dc2
Piesse, Jenifer
b85393d2-b4ae-49f2-87cd-8b5007c99e97
Strange, Roger
6f7b0a47-0014-4242-ad02-f3476a75322f

Hearn, Bruce, Piesse, Jenifer and Strange, Roger (2010) Market liquidity and stock size premia in emerging financial markets: The implications for foreign investment. International Business Review, 19 (5), 489-501. (doi:10.1016/j.ibusrev.2009.02.009).

Record type: Article

Abstract

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: South Africa, Kenya, Egypt and Morocco. These represent the largest and most developed equity markets in Africa and also act as regional hub markets. London is also included as a link between the emerging and developed financial markets. The Fama and French [Fama, E., & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3-56] three-factor model capital asset pricing model is augmented to take account of company size and illiquidity factors that feature in African financial markets. The results show that the premia associated with size are more prevalent than with liquidity although both are highly significant in both valuation and cost of equity estimates. The evidence suggests that the lowest cost of equity is achieved in the two major international markets of London and Johannesburg, while the less-advanced North African markets of Morocco and Egypt have higher costs of equity. The developing Kenyan market has the highest cost of equity, although the costs associated with the main market are less than one-third of that in the Alternative Investment Market.

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More information

Accepted/In Press date: 6 February 2009
e-pub ahead of print date: 2 April 2009
Published date: October 2010
Keywords: Africa, Capital asset pricing model, Emerging financial markets, Liquidity

Identifiers

Local EPrints ID: 423421
URI: http://eprints.soton.ac.uk/id/eprint/423421
ISSN: 0969-5931
PURE UUID: 17225d97-7c4a-4115-8af1-fcda73775474
ORCID for Bruce Hearn: ORCID iD orcid.org/0000-0001-9767-0198

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Date deposited: 21 Sep 2018 16:30
Last modified: 23 Jul 2022 02:22

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Contributors

Author: Bruce Hearn ORCID iD
Author: Jenifer Piesse
Author: Roger Strange

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