Determinants of Stock Market Development in Emerging

The Institute of International Studies – Rearrangement University MM 622 Investment Management Professor Dry. Felix Deadly Determinants of Stock Market Development In Emerging Economies: Is Thailand Different? Presented by Unusual Unpartisan Chairman Thingamabob Angola Anagram Waistcoat Lerdthannavaranont Master of Business Administration Abstract This paper is an adaptation from a study conducted by Charles Ammo Hearty from the International Monetary Fund. The paper examines the macroeconomics and institutional determinants of stock market development using data from 42 countries during the period 1990 to 2004.

The paper finds that macroeconomic factors such as income level, gross domestic development, banking sector development, private capital flows, and stock market liquidity are important determinants of stock market development. Additionally, it analyzes institutional factors such as political risk and stability and law and order are also important determinants of stock market development because they enhance the investors trust in the stability of the market. Analysis in this paper will also present that factor for the development of stock market In other countries can also explain the development of Stock market In Thailand.

Estimation Method VI. Results and Discussion 6 17 18 20 A. Macroeconomic Determinants of Stock Market Development 22 B. Institutional Quality and Stock Market Development Stock Market Development in Emerging Markets: 24 C. Explaining 25 Is Thailand Different? D. Limitations and recommendation for further research 26 E. Summary and Conclusion 27 Over the past decades, the world stock markets have expanded significantly and that stock market from developing countries mainly has played an important role in this.

Due to this significant change in the stock market around the world, many companies have shifted their financial structures from the usual practices to more advance resources such as capital inflows from developed nations. A key indicator of stock market development, the capitalization ratio (market capitalization as a proportion of GAP) rose during the past few years in countries such as Thailand where in 2001 the market capitalization was 24. 03% of the country’s GAP to a high as 87. 09% in 2010.

This paper studies macroeconomic factors and institutional factors that are determinants of stock market development in Thailand. The paper is compared to a research paper conducted by the International Monetary Fund using data of emerging economies from 42 countries during the period 1990 to 2004, globally. The paper specifically examines and analyzes the impact from domestic savings, investment, stock market liquidity, macroeconomic stability, private capital flows, banking sector development, and institutional quality on stock market development. The development of an economy’s financial markets is closely related to its overall development. Well-functioning financial systems provide good and easily accessible information. That lowers transaction costs, which in turn improves resource allocation and boosts economic growth. ” (“Financial sector data”) In this paper we will examine whether such relationship between the market growth and the financial sector is related. To measure stock market development we will use Market Capitalization as a percentage of GAP to measure stock market development.

Additionally, this paper will examine the impact of institutional quality on stock market development because we believe that institutions play an important role in the government plays a major role in the stock market due to they can control the political policies which affects the economy as a whole. Taxation rate, import/export regulations, and in some cases even the central bank are all controlled by the government. This paper will also provide specific events where institutional quality has affected the stock market significantly. Institutional quality is important for stock market development because efficient and accountable institutions tend broaden appeal and confidence in equity investment. Equity investment thus becomes gradually more attractive as political risk is resolved over time. Therefore, the development of good quality institutions can affect the attractiveness of equity investment and lead to stock market development. “(Hearty, 2008) The remainder of the paper is organized as follow: Section II discusses the literature on stock market ND economic growth.

Section Ill examines the main characteristics of stock markets in emerging market countries. Section V explains the methodology and discusses indicators of macroeconomic and institutional factors that are determinants of stock market development. Section VI describes the empirical results. Lastly, Section VII concludes this paper. II. Stock Market and Economic Growth: Theoretical and analytical issues. Savings are no longer limited to investing money into savings accounts in financial sectors anymore. With the emergence of stock markets, investors or individuals can both save and earn a specific return.

The emergence of the stock market helps to accelerate a countries economy significantly and also provides individuals with saving alternatives and improvements in investment decisions. Stock market helps to improve the economy by providing companies with alternatives to raise capital at a lower cost and additionally reduce risk in the banking sector from credit crunches. According to “Stock Markets: A Spur to Market Growth” by Ross Levine. Levine has identified that Stock markets affect economic activity through the creation of liquidity where investors are often reluctant to relinquish control of their savings for long periods.

Levine specified that liquid equity markets make investment less risky and more attractive because they allow savers to acquire an asset or equity and sell it quickly and cheaply if they needed access to their savings or alter their portfolios. Evidence linking stock market development to economic growth was presented in many studies conducted around the world but there has been no exact conclusion although many studies have shown a high correlation between the two.

A study conducted by Levine and Servers (1998) has find that stock market activity and economic growth are positively correlated and that tock market liquidity and banking development are both positively and robustly correlated with contemporaneous and future rates of economic growth, capital accumulation, and productivity growth. Although the numerous studies and research of the relationship of stock market and economic growth has gained attention in academic and policy discussions, there are few theoretical and empirical work on determinants of stock market development in emerging markets.

Cauldron-Resell (1991) has developed a model of stock market growth. More details of the model will be discussed in the later sections of the paper. Ill. Stock Market Development in Emerging Markets will therefore, provide an overview of the SEAN region where Thailand is considered a part of. However, the test results from data concerning determinants of stock market development will be presented in the later. In sass emerging stock markets evolved from small and shallow into sizeable and liquid markets integrated with the world financial system.

For example, The SEAN countries–Brunet Tarantulas, Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam–stand at the center of the most dynamic economic region of the world, and their performance has en part of the Asian “miracle” that has been well studied by economists and policymakers the world over. The region accounts for about 7 1/2 percent of the world’s population and a rapidly growing share of world output. Asia is currently undergoing a period of gradual liberalizing and transformation in the early sass.

Riding on a wave of strong economic growth and increasing investment flows, many countries in Asia is seen as the hotshots for trade and investments. The increase in consumer demand financial infrastructure and a large pool with a large Asian perfect confluence of factors unique to what has been described as a miracle Asia. Within Asia, SEAN countries, such as Singapore, Thailand, Malaysia and to some extent Indonesia, whose economies were export driven, recorded GAP growth rates well above 7% Joining the likes of Taiwan, Hong Kong and Korea as the new emerging tigers.

The economic achievements of the countries in this region over the past quarter century have little parallel. As a result of strong, sustained economic growth since 1970, Singapore has now Joined the ranks of the rich industrial countries, while Indonesia, Malaysia, and Thailand have seen their real per capita incomes rise more than threefold over this period; Please refer to Table AY. More recently, the Philippines, too, has seen its growth rate rise closer to that of the other countries in the region. Table AY presents market development indicators.

Values in columns 2 thru 5 and 8 thru 11 are the average values of the corresponding indicator over the period indicated in the column 6 for each country. The number in the second column is the average of the number of firms whose stocks are traded in the stock market. Column 3 and 4 (and columns 9 and 10) give the average of the ratio of the stock market capitalization and the total value of all stocks traded throughout the year over GAP. Finally, the numbers in column 5 (and column 11) are the average of the ratio of column 4 over column 3 and are a measure of liquidity in the market.

Figure AY Panel (a) presents the ratio of market capitalization over GAP, which is used as a measure of the market size. Two measures of market liquidity are presented in Panel (b) and (c) of Figure AY . The first is the ratio of total value traded over GAP throughout the year. This indicator is intended to measure the liquidity of a market in relation to the size of the economy. Turnover ratio is the second measure of liquidity. It measures equity relative to the value of all shares outstanding and is inversely related to transaction costs in the stock market.

Finally, as a measure of public equity financing among domestic companies, Figure AY panel (d) shows the number of companies whose shares are traded on the stock market. Three year averages of these indicators are presented in Table AY . There are several important observations to make about the behavior of a measure of the market during this period. First, it is evident in both Figure AY and Table AY that the five of emerging stock markets went through a rapid increased in the late sass and the early sass. Market size and liquidity indicators peaked during the period 1993 to 1995.

In a matter of less than a decade, many emerging markets have reached market size and liquidity measures that were close to many mature markets. Second, there are obvious differences in the emerging markets in terms of market development. For example, according to all four measures of market development, Taiwan, Korea and Malaysia have easily held among mature markets as early as 1988. It was the fact that these markets are affected positively by the Securities and even after the East Asian crisis and the liquidity of the market, compared with the mature markets.

IV. The Stock Exchange of Thailand The history of the of the Thai Stock market can be dated back to July 1962 when a private grouped established an organized stock exchange as a limited partnership. It has later changed into a limited company by the name “Bangkok Stock Exchange Co. , Ltd. ” in 1963. Although its well foundation the firm was not properly supported by the government together with a limited number of investors whom understands the equity market, the firm has soon become inactive and ceased its operations in the sass.

Although the stock exchange has failed, the concept of an orderly and officially purported securities market in Thailand has attracted the nation’s attention. Dated back to the year 1961, Thailand has first started its five year development plan called “National Economic and Social development plan”, a plan to promote economic growth, a year before the Bangkok stock exchange firm was established . It wasn’t until in the year 1967, when the idea of an establishment for securities market was brought to the Second National Economic and Social Development Plan.

Recommended by the World Bank in 1969, the Thai government has acquired the services of Professor Sidney M. Robbins, ex-Chief Economist of the United States Securities and Exchange Commission, from Columbia University to study the development channels of the Thai Capital Market. Within the very same year the Bank of Thailand, Thailand Central Bank, formed a working group on Capital Market Development and was assigned the task of establishing the stock market. “In 1972 the Government took a further step in this direction by amending the “Announcement of the Executive Council No. 8 on the Control of Commercial Undertakings Affecting Public Safety and Welfare”. The changes extended Government control and regulation over the operations of finance and securities companies, which until then ad operated fairly freely. Following these amendments, in May 1974, long-awaited legislation establishing “The Securities Exchange of Thailand” (SET) was enacted. This was followed by revisions to the Revenue Code at the end of the year, allowing the investment of savings in the capital market.

By 1975 the basic legislative framework was in place and on April 30, 1975, “The Securities Exchange of Thailand” officially started trading. On January 1, 1991 its name was formally changed to “The Stock Exchange of Thailand” (SET). ” (Stock Exchange of Thailand) B. Structure, Operations and Regulation The Securities and Exchange Act of 1992 (SEA) stipulates the Securities and Exchange Commission (SEC), a unified supervisory agency of the regulator of the Thai Capital Market and the SEC overseas to develop the Kingdom’s capital market provides a successful development (See Figure Bal for SET structure chart).

The requirements in each market are as below: Primary Market A company issuing new securities; carrying out an initial public offering (PIP) or offering additional securities to the public must first apply for SEC approval and comply with its filing requirements, then the SEC review the financial status and operations of the company before allowing the firm to issue secures to the public.

Secondary Market Continuing from the initial public offering, securities may be traded in the secondary market once the issuer has applied for and been granted approve by the SET Roles of the Stock Exchange of Thailand The SETS serve as a centre the tracing of listed securities and provide the essential systems needed to facilitate securities trading and also undertake any business relating to the Securities Exchange such as a clearing house, securities depository centre as well as undertake any other business approved by the SEC C.

Main Characteristics This paper uses the capitalization ratio and the number of listed companies to measure the size of the Stock Exchange of Thailand. The Capitalization ratio is defined as the value of domestic equities traded on the stock exchange relative to GAP. As Figure CLC shows the capitalization ratio increases from 14. 29 in 1990 too high of 104. 79 in 1993. The high growth of market capitalization is correlated to the number of listed companies in a way.

However, in the year 1997 although there is a steady increase in the number of listed companies in the company, market capitalization has decreased to a low of 15. 0%. This was due to the Asian Financial crisis which has started out from Thailand due to the country’s lack of foreign currency to support its fixed exchange rate along with high foreign debt. Market Depth Market Depth refers to liquidity or the ability to buy and sell shares. The paper measures the activity of the stock market using total value as a share of GAP, which gives the value of stock transactions relative to the size of the economy.

This measure is also used to gauge market liquidity because it measures trading relative to economic activity. Additionally, we will examine the turnover ratio which is defined as he ratio of the value of total shares traded and market capitalization. It measures the activity of stock market relative to the size of the market. Analysts usually use this information to measure transaction cost; High turnover implies low transaction cost and high efficiency. V. Methodology and Data Cauldron -Resell developed a behavioral structural model of stock market development.

The model shows that stock market development is the result of the combined effect of economic growth and liquidity on both stock prices and the number of listings. To examine the validity of this model, Cauldron-Resell used data from 42 countries from the main active stock markets in the world with annual observations from 1980-87. The analysis shows that stock market liquidity and economic growth are important determinants of stock market growth. B.

The modified Cauldron-Resell Model This paper looks at the institutional and macroeconomic determinants of stock market development in emerging markets. As mentioned in the previous section several researches conducted around the world has identified a positive correlation between the institutional and macroeconomic factors in stock market development. Kombi and Tarts (2012) showed that show that stock market liquidity, income level, and banking sector have positive effect on stock market development.

Institutional quality on the other hand also plays an important role in the stock market development. Androids and Hearty (2007) finds that good quality institutions such as law and order, democratic accountability, bureaucratic quality as important determinants of stock market development for example in Africa as they reduce political risk and enhance the viability of external finance. Beakers, Harvey ; Landau (2000) provides evidence that higher levels of political risk are related to higher degrees of market segmentation and consequently low level of stock market development.

Due to the factors used to present our research is an extension of the model, we modify to incorporate other financial, economic, and institutional variables Nanking sector development, political risk, and private capital flows in explaining stock market development in emerging markets. We estimate the following regression: Hit = al+tit-1 + ;Mit+wapiti+Tie Where Y is stock market capitalization relative to GAP, al is the unobserved country specific fixed effect, and Testis the usual white noise.

M is the matrix of macroeconomic variables made up of GAP per capita, credit to the private sector as a percentage of GAP and its square, gross domestic investment as a percentage of GAP, stock market value traded as a percentage of GAP, private capital flows as a percentage of GAP, reign direct investment as a percentage of GAP, macroeconomic stability (measured by current inflation and the real interest rate), and gross domestic savings. The P variables are measures of institutional quality and include political risk, corruption, law and order, democratic accountability, and bureaucratic quality.

C. The Data The method taken in this paper is to point out the impact of relevant variables such as Income level, Banking Sector, Saving and Investment, Stock Market Liquidity, Macroeconomic stability, Institutional Quality (economic, financial, political risk), are related to Thailand Stock market development. Data used in the test are from the period 1996 to 2008. The reasons for the usage of these variables are described below: Dependent Variable: Stock Market Development The dependent variable of interest is stock market development.

In this paper we will measure the stock market development using market capitalization as a proportion of GAP. This measure equals the value of listed shares divided by GAP. The assumption behind this measure is that overall market size is positively correlated with the ability to mobile capital and diversify risk on an economy-wide basis. Income Level The increase in income will create new demand for financial services; put forth to establish more or larger financial institution in the country. Higher income growth can promote development in stock market.

Furthermore, higher income usually goes hand in hand with better welfare, better education, and better business environment. In this paper, we have used the log GAP per capita in US Dollars to measure the effect of income level through stock market development. Banking Sector Development Bank of Thailand stated in 2011 annual report; overall financial position of the Nanking system remained strong and stayed well above the international standards. The banking system recorded higher operating profit while corporate lending slowdown due to the flood.

After the flood, high demands in banking services make rise to higher interest. So the net interest margin increased from 2. 8% to 2. 9% in 2010 and 2011 respectively. Due to many critical crisis happened in Thailand during the most recent few year, banking sector is becoming important to the economic development and more in the development of stock market because it help support investors with liquidity by advancing credit, and facilitating savings. To determine the correlation between the Thai banking sector development and the Thai stock market development, MM relative to GAP is used as a measure of financial debt.

We use the to GAP as a measure of banking sector development and also include the square of bank credit to private sector as a percentage of GAP in regression to understand how banking sector development and stock market development are correlated. Saving and Investment It is not wrong to say that a stock market is the intermediate saving of the investors. In this paper, we also measure the saving and investment as one determinant that would more or less correlated to the stock market. Occasionally it is understood that the larger of the saving, the higher the amount of capital flows to stock marker.

So, gross domestic savings and gross domestic investment were used as percentage of GAP in order to determine how relevant of saving and investment and stock market. Stock Market Liquidity: Liquidity is “the degree to which an asset or security can be bought or sold in the market without affecting the asset’s price; characterized by a high level of trading activity’ (Investigated) Liquid markets provide investors an access to their savings which they can liquidate their investments easily, quickly and thus boost their confidence in stock market investment.

In addition, liquid markets help induce more investors to invest in the stock market thus increasing the capitalization of the market. In this paper, the stock market liquidity was measured by using value traded as a percentage of GAP. The ratio measures the value of equity transaction relative to the size of economy; measures the degree of trading relative to the size of economy. Macroeconomic Stability: Some similar researches, macroeconomic stability has been measured to exert effects on stock market development; however, they found no significant relationship between macroeconomic stability and stock market development.

In this paper, we use real interest rate and current inflation to define the relationship between macroeconomic stability and stock market development. We agree that the higher levels of macroeconomic stability encourage investors to participate in the stock market because the investment environment is predictable. Moreover, macroeconomic stability influence firms profitability and the prices of securities in he stock market are likely to increase. Investors who experience a capital gain are more likely to put their savings to the stock market by increasing their investments, and this will enhance stock market development.

Private Capital Flow: Private capital flows consist of net foreign direct investment and portfolio investment. Foreign direct investment is net inflows of investment to acquire an interest in an enterprise operating in an economy. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of aments. In this paper, private capital flow is defined by using foreign investment as percentage of GAP and net private capital flows as a percentage of GAP.

Before an investment is made, the foreign investors need to study the local laws and regulations applicable to foreign investors but more importantly the financial, economic and political stability of the country. According to Edison (2003) there are three broad measures of institutional quality. First is the quality of governance, The second is the legal protection of private property and law enforcement. The third s accountability and the limits placed on the executive and political leaders.

All these measures are conducted using country experts. However, there is one certain flaw to these measures. The present of a bias information is involved in such measures. As these measures may be used by foreign investors, these country experts may have a tendency to distort certain numbers to their favor. Additional, each country institutional quality view is different from the other. While some may view certain political actions as a positive influence some may consider such actions to be negative.

As mentioned in the previous section. This paper is an adaptation from Hartley study on the macroeconomics and institutional determinants of stock market development in 42 emerging countries and South Africa. According to Hartley, he has used political risk indicators for institutional quality determinants from the International Country Risk Guide as a measure. Specific measures used in Hearty study include the effect of law and order, bureaucratic quality, demo accountability, and corruption.

However due to limited resources and data, this paper will use data provided by the World Bank Group. The World Bank Group collects data and resources globally and provides a comparative index for each of the six board dimensions for institutional quality accordingly. The six dimensions identified by the World Bank Group are Voice and Accountability, Political Stability and Absence of Violence, Government Effectiveness, Regulatory Quality, Rule of Law, Control of Corruption.

This paper will only take into consideration 4 of the 6 dimensions which is somewhat comparable to the 4 dimensions performed by Hearty. The political risk indicator is rated on a -2. 5 to 2. 5 scale, where -2. Symbolizes a weak governance and a 2. 5 will symbolize a strong governance. We can somewhat hypothesize that a strong governance would have a positive impact on the stock market development and a weak governance a negative impact on the stock market.

To apply to the model use for the test this paper converts such value into a scale of O to 5. This paper will use 4 political risk dimensions from the World Bank Group which include Political Stability and Absence of Violence, Regulatory Quality, Rule of Law, Control of Corruption. Political Stability reflects perceptions of the likelihood that the government will be stabilized or overthrown by unconstitutional or violent means, including politically- motivated violence and terrorism.

Regulatory Quality reflects perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. Rule of law reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. Lastly, Control of

Corruption reflects perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. The effect of institutional quality to the stock market will be presented in another section of the paper. D. Estimation Method Given the panel nature of our dataset this paper uses paper data techniques in estimating the regression models. All the relationships to be studied can be characterized by the Joint nonentity of most variables involved. That is, most