Stock returns, volatility spillover, and other financial issues in emerging markets

Citation

Kiymaz, H. (2013), "Stock returns, volatility spillover, and other financial issues in emerging markets", International Journal of Emerging Markets, Vol. 8 No. 2. https://doi.org/10.1108/ijoem.2013.30108baa.001

Stock returns, volatility spillover, and other financial issues in emerging markets

Article Type: Editorial From: International Journal of Emerging Markets, Volume 8, Issue 2

Emerging markets are becoming increasingly important for both practitioners and academicians. While 2007-2009 financial crises continue to linger in the developed markets, the emerging markets are doing well recently even though the co-movement between emerging and developing markets have been increasing during the past decade (Kiymaz, 2002, 2003; Gray, 2009; Majid and Kassim, 2009). For example, the stock markets in Colombia, Turkey, and Thailand are up about 25 percent in 2012. There are also long-term trends in emerging markets that favor investing in them.

The relationships between emerging and developed markets continue to have the attention of academicians. Among earlier studies, Kiymaz (2002) examines the short and long-term relationship among the emerging Latin American equity markets (Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela), and three developed equity markets (the USA, the UK, and Japan) by using cointegration analysis for the period of 1988 and 1997. Kiymaz concludes that there is no long-run relationship among these markets. The lack of long-run relationship implies existence of potential long-run benefits in risk reduction from diversifying in Latin American markets. The study further reports one-way causality running from Japan, the UK, and the USA to most of the emerging Latin American markets. In a follow up study, Kiymaz (2003) extends this investigation to the European frontier markets (Bulgaria, Croatia, Estonia, Lithuania, Romania, Slovenia, and Ukraine), African/Middle Eastern frontier markets (Kenya, Lebanon, Mauritius, and Tunisia). Findings show that there is very limited cointegrating relationship among these markets. For example, only one of the 11 European frontier markets and two of the African/Middle eastern markets move together with US and UK markets.

The issues of volatility and stock market integration have also been included in previous issues of International Journal of Emerging Markets. Among them, Majid et al. (2009) examines the dynamic linkages among emerging stock markets (Malaysia, Thailand, Indonesia, the Philippines and Singapore) during the pre- and post-1997 Asian financial crises. The authors show the stock markets in the region are cointegrated both during the pre- and post-1997 financial crisis. However, the markets are moving towards a greater integration, particularly during the post-1997 financial crisis.

Similarly, Gray (2009) investigates financial contagion among emerging European Union countries and report the linkages among these countries strengthen after the beginning of the banking crisis of 2007 compared with before, while their ties the euro remain stable. Majid and Kassim (2009) extend the discussion by investigating the impact of 2007 financial crises to emerging markets of Indonesia and Malaysia. Their findings support the view that stock markets tend to show greater degree of integration or increased co-movements during the crisis period, resulting in lesser benefit of diversification to market participants.

Recently, Batareddy et al. (2012) investigate the stability of long-run relationships among emerging Asian countries and Japan and the USA. The authors support the presence of one long-run relationship among emerging and developed stock markets. Both domestic and external forces affect stock market behavior, leading to long-run equilibrium but the individual Asian emerging stock markets display stronger linkages with US market rather than with their neighbors. In summary, the previous literature show increased integration of financial markets around the world.

The current issue presents a collection of five articles outlining various financial issues in emerging markets. A few of them are extension of discussion on market integration and volatility spillovers. In the first article, Kumar investigates the returns and volatility spillover between stock market and exchange rates for the India, Brazil, and South Africa (IBSA) countries during the last decade. The increased interdependence among financial markets is getting attention of both market participants and policymakers. As a result, understanding volatility spillovers mechanism would help market participants as well as policy makers. The article uses multivariate BEKK GARCH and Spillover Index to capture the volatility transmission between the stock and foreign exchange market for the same period. Findings suggests a integration relations between stock and foreign exchange markets and indicates the existence of bi-directional volatility spillover between stock and foreign exchange markets in the IBSA countries.

Financial economists have investigated the impact of financial news releases on market volatility. While various studies have highlighted the connection between the volatility of stock prices and identifiable news releases. The second article, by Malhotra, takes this discussion to Indian market and provides evidence on changes the time varying volatility around bonus and rights issue announcements. The findings show that historical volatility around bonus and rights issue has increased around days of announcement. The increase in volatility after the bonus issue announcement period confirms that the market reacted to the bonus issue announcement and there is increased trading activity among the investors. The author reports higher volatility persistence in the post bonus and rights issue announcement periods. The reasons for increased volatility is attributed to the fact that rights issue is used as a mechanism to raise funds from the current investors’ base, as against raising funds from the open market. The findings further suggest the existence of a “calm before the storm” effect in the data series. This phenomenon describes that the prices fluctuation is less before the announcement but more in post announcement period for the whole sample. As event announcement influences the investors’ sentiments, market activity increases, which causes price fluctuations and hence the volatility increases.

The author argues that from investors’ perspective, the time varying nature of volatility indicates that stock prices fluctuate because of announcements. The investors can anticipate the same and design their investment strategies accordingly. From the firm’s perspective, the study highlights that firms can use bonus and rights issue announcements as a signaling device. Firms anticipate an increase in volatility after the announcements. The news in the market is captured in the stock prices immediately and hence, the firms should release the news carefully after observing the market sentiment. The firms should consider the expected increase in volatility before releasing any significant financial information about the firm in the market. Signaling theory holds true in the case of Indian stock market.

The next paper in the collection, by Baghdadabad, proposes a new methodology in evaluation international mutual funds. The authors demonstrate that optimized variance (OV) is an important determinant in the performance evaluation measures by extending previous literature on optimizing the variance and the risk-adjusted measures. The empirical evidence shows that new optimized measures perform better than benchmark index. Furthermore, these optimized measures have close correlation with the conventional performance measures.

Their results therefore highlight the importance of using the new optimized measures along with the conventional measures in the evaluation of mutual fund performance. The paper uses seven optimized measures able to evaluate the performance of international mutual funds over the period of 2001-2010. The most important result of this paper is that new optimized measures are able to supersede with the conventional measures. Thus, different managers and investors can employ the new modified measures to evaluate the performance of mutual funds and to select the optimum funds for efficient investments. The evidence shows that although the average of OV associated to the crisis period (during crisis) is less than two other periods of pre- and post-crisis, against the average of the optimized measures for this research period represents the lowest performance in comparison with other research periods. This result is compatible to theory of performance evaluation under crisis condition, in which portfolios generally experience lower performance during crisis condition.

In the fourth paper, Adaoglu uses an emerging market index (Istanbul Stock Exchange (ISE) 30) and foreign investor trading activity to establish a Granger causality relationship between the monthly net foreign investor flows and the monthly stock returns. The results of such study are particularly useful for financial managers, portfolio managers, traders, domestic and foreign investors dealing with the ISE, and lead the way for further research on the effects of foreign investors in the ISE such as the base broadening and price pressure effects. This study not only use the full sample period but also consider the structural changes in foreign investor trading activity. Turkey’s negotiation with European Union provides a good opportunity to test the impact of structural changes on causality of foreign fund flow and market index. Specifically, Adaoglu focuses on two periods; the pre and post EU accession negotiations periods. Especially, during the post EU accession negotiations period, there have been significant increases in the foreign investor custody ratio measured by the foreign investor trading volume ratio and the total foreign investor trading volume. For the pre EU accession negotiations period, unidirectional Granger causality is found running from monthly stock returns to monthly net foreign investor flows. However, the causality relationship disappears during the post EU accession negotiations period. The author also report that the stock returns contemporaneously affect the monthly net foreign investor flows in all periods, but the relationship is strongest for the post EU accession negotiations period.

The final paper, by Komera, examines the post-bankruptcy market as well as operating performance of the Indian listed firms. The author analyzes the analysis of short run market performance and reports that the market is not considering these events of emergence from bankruptcy as a positive surprise.

The results show that the stock returns following earnings announcements reveals that the Indian market is informantionally efficient in pricing the stocks. A detail analysis of sample indicates that firms’ affiliation to business groups seems to influence their market performance negatively. It is evident from the analysis of post-bankruptcy operating performance that there is a drop in the operating performance during the post event period and the median assets and sales growth continue to be less than that of their matching firms. Findings raise questions over the efficiency of reorganization process and calls for the revamping of Indian corporate bankruptcy mechanism.

In summary, the papers in this special issue highlight the diversity of topics relating to emerging markets in various regions as well as increased importance of emerging markets. These markets are becoming increasingly integrated with developed markets indicating that volatility spillovers and contagion issues will become more important. Market participants will need to consider how they could use these trends in designing their trading strategy.

Halil KiymazArea Editor – Financial Markets