Academic journal article Quarterly Journal of Business and Economics

An Empirical Analysis of Emerging Stock Markets of Europe

Academic journal article Quarterly Journal of Business and Economics

An Empirical Analysis of Emerging Stock Markets of Europe

Article excerpt

Introduction

The demise of communism in Russia and Eastern Europe has led to increased opportunities for investors seeking greater potential returns and portfolio diversification. There is an important political context in which all of this occurred: the fall of communism and subsequent rise of populism, liberalization, modernization, and privatization have resulted in a more competitive economic landscape. This new political landscape also has opened stock markets to foreign investors, thus attracting much needed foreign capital for economic development.

Poland and Czechoslovakia were the first Eastern Bloc countries to initiate economic reforms. Other countries soon followed suit. The International Finance Corporation (IFC) now classifies seven countries in Europe as emerging: the Czech Republic, Poland, Russia, Hungary, Greece, Slovakia, and Turkey. The IFC defines an emerging stock market as any stock market located in a developing country, as defined by the World Bank's GNP per capita criterion for a developing country. In addition, the IFC considers size (as measured by market capitation) and liquidity (as measured by turnover) of a market in classifying that market as emerging and in deciding whether to include the country's securities in its emerging market data base (EMDB).

Emerging markets, in general, have gained the attention of investors, researchers, and policy makers in the last ten to fifteen years because of several factors. Perhaps the leading factor is their sound performance over the period, with yields in some markets far exceeding those of developed markets. Given the current international status and interest in emerging stock markets, the focus of this study is the stability, predictability, and volatility (including the persistence of volatility and time-varying risk premium) in the seven European emerging stock markets. Several papers have focused exclusively on developed stock markets and a few emerging markets in Asia, Europe, and Latin America. The primary focus of this study is the seven emerging markets of Europe. This study specifically examines whether these markets provide an avenue for investors seeking diversification and investors' potential returns over time to the changing risk patterns in these equity markets.

There is substantial diversity among the world's emerging markets in terms of infrastructure, market size, and liquidity. Some investors believe that emerging markets in Eastern Europe have greater growth potential over the next decade compared to the emerging markets of Asia and Latin America. European emerging markets may be viewed by investors as better quality than what is available in Asia or Latin America because the infrastructure and regulations of Eastern Europe are closer to that of developed markets. Furthermore, the high education levels in Eastern Europe, combined with lower salary levels compared to the developed world, make direct foreign investments and outsourcing production favorable.

According to International Monetary Funds (IMF), emerging market stocks currently represent approximately 10.4 percent of the capitalization of the world's equity markets. In addition, the IMF predicts that emerging markets will grow twice as fast as those of industrialized countries through this decade. Adding to the attractiveness of emerging markets are the potential diversification benefits. Emerging markets tend to have low correlations with developed markets, thereby providing overall risk reduction benefits to the portfolio. Although there may be a number of factors to explain the exceptional development of emerging markets, the most plausible explanation is that economic reform in these markets has led to a rapid increase in equity flows from the industrial to developing markets. (1)

The deregulation and privatization programs in European emerging markets and capital mobility may increase the volatility of these markets. …

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