International Finance: Contemporary Issues

By Dilip K. Das | Go to book overview

13

TOWARDS THE THEORY OF WORLD STOCK MARKETS

An overview

Jorge R. Calderón-Rossell


INTRODUCTION

Interest in foreign stock markets has significantly increased during the last two decades, particularly during the 1980s when international portfolio investments seem to have increased substantially. 1 Evidence of this interest is reflected in the increasing literature on the subject which is briefly reviewed in this chapter. While advances have been made in both the theory and the empirical analysis of international portfolio investments, significant and fundamental research is still needed on several fronts to advance our understanding of the establishment, functioning, growth and interaction of stock markets with the economies in which they operate. This understanding is critical in order to confidently provide policy recommendations leading to the further development of world stock markets.

Studies of international stock markets have often been born by extending the concepts and the knowledge on the functioning of domestic stock markets. Because of this, the recent domestic markets literature is also briefly discussed in this chapter. Particularly relevant contributions are those analysing the functioning of stock markets and their interaction with economic variables and policies. Different stages of economic development appear to impinge on stock market development. With this notion, a subset of the literature has focused on emerging markets, i.e. those operating in developing economies. The bulk of the substantive literature, however, has focused on developed markets, i.e. those operating in developed economies.

Stock markets, on the other hand, do not work in isolation as they form part of the financial system and arise as a consequence of the international monetary system. To the extent that they were considered relevant, studies in these areas that could throw some light on the development of international stock markets are also briefly reviewed.

Central to the study of the world stock markets is also the controversy between integration and segmentation of capital markets, which by necessity needs to be considered also.

The purpose of this chapter is to review briefly what we know so far about international stock markets, with special attention paid to identifying possible policy implications. The study does not pretend to be exhaustive. A special effort is made to highlight issues that may provoke further research which would advance our understanding of stock markets. Because of this, the chapter is basically descriptive and only attempts to be analytical on certain relevant theoretical issues. Such understanding is essential for providing policy recommendations leading to further development of international stock markets.

The following section focuses on the international asset pricing literature. The assumptions of CAPMs that have been extended to international markets are examined in detail, with

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