Emerging Financial Markets 2: Measuring Market Return And Volatility Prof. J.P. Mei.
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Transcript of Emerging Financial Markets 2: Measuring Market Return And Volatility Prof. J.P. Mei.
Emerging Financial Markets 2: Measuring Market Return And Volatility
Prof. J.P. Mei
Major Emerging Equity Markets
Rank MKt MCP Rank Mkt TVol Rank Mkt Nlist
1 US 11.3 1 US 10.2 1 US 8851
10 HK 0.41 2 TW 1.2 2 IN 5843
13 TW 0.28 7 HK 0.48 7 SL 872
15 BR 0.25 10 CH 0.37 8 PK 781
16 SA 0.23 14 BR 0.20 9 KO 776
Note: MKT-market Value, Tvol-Trading Volume, Nlist-Number of listed companies
6
Various Forms of Capital Controls Various foreign exchange controls are often
imposed in EM.
Different class of shares and their pricing:
shares for foreign investors may sell at a
discount or premium to domestic shares.
(E.G., A & B shares in China, TSMC)
These may be investment opportunities but
not arbitrage opportunities.
6
One Stock, Two PricesFROM 1-1-99 TO 1-17-01 WEEKLY INDEXED
J F M A M J J A S O N D J F M A M J J A S O N D J50
100
150
200
250
300
350
400
450
500
550
600
TAIWAN SEMICON.SPN.ADR 1 ADR = 5 SHARESTAIWAN SEMICON.MNFG.
HIGH 580.42 2-4-00 LOW 100.00 1-1-99 LAST 248.34HIGH 379.39 2-11-00 LOW 100.00 1-1-99 LAST 208.44Source: DATASTREAM
Investor’s Nightmare? Lack of transparency and information
disclosure: inside dealing When an Event is not an Event:
Measurement of inside dealing Front-running: you may be ripped off. High transaction costs: over 5% for a round
trip. Many trades may fail to settle. Market illiquidity: can not sell your position
without taking substantial price cut. 7
Cost of a Round Trip -- Purchase andLater Sale of an Individual Stock
Bid/Offer Country Commission Stamp Taxes Spread Total
Argentina 1.00% 0.48% 1.25% 2.73%
Brazil 1.00 0.14 2.48 3.62
Indonesia 1.30 0.30 1.50 3.10
Korea 0.80 0.50 2.25 3.55
Malaysia 1.20 0.10 1.09 2.39
Thailand 1.30 - 1.89 3.19
Germany 0.50 - 0.49 0.99
Japan 0.40 0.30 0.75 1.45
United States 0.13 - 0.27 0.40
Source: Morgan Stanley International Portfolio Desk and Authors'Estimates.
Average Number of Days Taken to Collect Dividend, 1995(Source: Global Securities Consulting Services, Ltd.)
34.2
16.214.8
6.55.3
4.5
2.5 2.11 0.7
0
5
10
15
20
25
30
35
40
Philippines India Venezuela Argentina Brazil Thailand Korea UK UnitedStates
Germany
GSCS Settlement Benchmark(As of end 1996, Source: Global Securities Consulting Service, Inc)
95.291
86.1 85.8
75.6
52.3
1.3 0.7
-10
0
10
20
30
40
50
60
70
80
90
100
110
Turkey Brazil Malaysia Mexico Philippines Indonesia South Africa India
Accounting issues Poor financial accounting: hard to
value assets
(How do you value a machine that
has never been used?)
Are accountings numbers useless?
How to become rich using GAAP?
9
Table 1: Original Balance Sheets
Company A Company BCash: 100 Cash: 100Real Asset: 100 Equity: 200 Real Asset: 100 Equity: 200Shares Outstanding :200 Shares Outstanding :200Book Value per share: 1.00 Book Value per share: 1.00
Table 2: Balance Sheet when A Buys 100 of B's stock
Company A Company BCash: 0 Cash: 200Real Asset: 100 Equity: 200 Real Asset: 100 Equity: 300Investment: 100Shares Outstanding :200 Shares Outstanding :300Book Value per share: 1.00 Book Value per share: 1.00
Table 3: Balance Sheet with 200 in Total Cross Holdings
Company A Company BCash: 100 Cash: 100Real Asset: 100 Equity: 300 Real Asset: 100 Equity: 300Investment: 100 Investment: 100Shares Outstanding: 300 Shares Outstanding: 300Book Value per share: 1.00 Book Value per share: 1.00
Table 4: Balance Sheet with 3600 in Total Cross Holdings
Company A Company BCash: 100 Cash: 100Real Asset: 100 Equity: 2000 Real Asset: 100 Equity: 2000Investment: 1800 Investment: 1800Shares Outstanding: 2000 Shares Outstanding: 2000Book Value per share: 1.00 Book Value per share: 1.00
2
Measuring Emerging Market Returns Local currency returns vs. dollar returns Arithmetic, geometric, and internal rates of
return (used for investment projects) Geometric means are always smaller or
equal to arithmetic means. If one compound geometric mean returns,
one will always get the actual return during the sample period.
One should use geometric returns in emerging markets due to high volatility.
Emerging Market Return Distribution Generally High Serial Correlations in Short-
run. (Basis for Momentum strategies)
The Presence of Long-term Mean Reversion for many EMs. (Basis for Value strategies)
The Presence of Excess Skewness and Kurtosis (Fat Tails, high probability for large surprises)
Conventional Derivatives Pricing Tends to Under-price in Emerging Markets Due to Excess Kurtosis.
Average Dollar Return and Volatility of Selected Markets, 1977-1998
Country
Average
Annual
Return
(%)
No. of Years
In Which
Returns Were
Positive
No. of Years
in Which
Returns Were
Negative
Highest
Yearly
Return
(%)
Lowest
Yearly
Return
(%)
Volatility
Index
(U.S.=100)
Argentina 13.1% 12 10 395.6% -61.9% 827
Brazil 4.1 11 10 150.2 -64.2 822
Chile 20.2 15 6 148.2 -56.9 609
Greece 4.7 11 9 141.6 -57.3 570
Hong Kong 19.7 15 7 119.9 -40.3 681
India 8.8 13 8 104.0 -34.2 402
Thailand 5.0 11 9 108.9 -78.4 471
United States 15.7 18 3 37.2 -4.6 100
Data Source: International Finance Corporation.
Summary Statistics-April 1991 - March 1996
Country Start DateArithemetic
ReturnGeometric
ReturnStandarddeviation Skewness Kurtosis
NomalityTest
P-value
FirstOrder
Autocorrel
BetaMSCIWorld
BetaMSCI
AC World
BetaIFCG
CompositeArgentina Apr-91 35.5% 25.6% 56.7% 3.09 16.92 0.00 0.06 1.53 1.69 0.91Brazil Apr-91 44.3% 37.1% 52.2% 0.89 1.51 0.00 0.09 1.19 1.43 1.38Chile Apr-91 24.7% 23.6% 26.6% 0.35 -0.43 0.04 0.23 0.09 0.20 0.64Colombia Apr-91 40.5% 39.0% 40.1% 1.33 2.02 0.00 0.54 -0.05 -0.01 0.25Greece Apr-91 -2.7% -5.5% 24.1% -0.34 0.06 0.32 0.16 0.52 0.54 0.28India Apr-91 12.6% 6.3% 36.8% 0.67 1.47 0.20 0.25 -0.60 -0.49 0.69Indonesia Apr-91 9.5% 5.5% 29.2% 0.15 0.09 0.83 0.18 0.58 0.72 1.04Jordan Apr-91 10.0% 9.4% 14.3% 0.34 -0.80 0.00 0.07 0.11 0.13 0.11Malaysia Apr-91 20.4% 19.1% 23.9% -0.06 1.03 0.26 -0.16 0.57 0.67 0.87Mexico Apr-91 15.7% 8.5% 37.5% -1.01 2.04 0.09 0.33 0.83 1.08 1.40Nigeria Apr-91 37.5% 12.7% 69.5% 1.19 11.92 0.00 -0.04 1.15 1.14 -0.05Pakistan Apr-91 22.4% 18.1% 35.3% 1.03 1.92 0.01 0.30 0.06 0.15 0.57Philippines Apr-91 24.1% 22.4% 28.7% 1.37 4.47 0.18 0.02 0.54 0.69 1.10Portugal Apr-91 8.3% 6.6% 19.6% 0.41 1.55 0.29 0.01 0.98 1.01 0.25S. Korea Apr-91 7.8% 4.7% 26.0% 1.07 1.75 0.03 0.04 0.41 0.51 0.68Taiwan Apr-91 7.3% 1.4% 37.1% 2.24 7.65 0.00 0.08 0.69 0.88 1.42Thailand Apr-91 20.1% 17.2% 30.0% 1.08 1.85 0.03 0.03 0.20 0.35 1.14Turkey Apr-91 13.6% -3.9% 61.2% 0.64 0.42 0.04 0.08 -0.12 -0.01 0.87Venezuela Apr-91 -7.0% -16.8% 45.8% -0.45 1.91 0.24 -0.25 0.45 0.54 0.57Zimbabwe Apr-91 4.8% -1.1% 34.9% 0.38 0.87 0.37 0.32 0.84 0.90 0.55MSCI World Apr-91 11.2% 11.1% 10.7% -0.32 -0.34 0.08 -0.25 1.00 1.01 0.20MSCI AC W’d Apr-91 11.0% 11.0% 10.5% -0.23 -0.39 0.14 -0.22 0.98 1.00 0.25IFCG Comp. Apr-91 11.4% 10.6% 16.4% 0.93 3.47 0.08 0.40 0.47 0.62 1.00*Composite: IFC Global Composite; AC World: MSCI All Country Index. Source: IFC Global Indices, MSCI Indices. Monthly returns in US Dollars.Source: Erb, Harvey and Viskanta
The Nature of Market Volatility
International Volatility Comparison: EM Could Be 10 Times More Volatile.
High Variation in Mean and Standard Deviation of Returns.
Correlation of Market Volatilities (The “Asian flu”: market volatilities tend to increase at the same time.)
A Simple Model of Average Volatility:positively Related to GDP Growth, Negatively Related to IICCR.
Systematic Risk: Positively Related to GDP Growth. Very Weak Relationship Between Beta (EM & world)
and Mean Returns (volatilities do better) 3
Time-varying Volatility (S.D. of Monthly Dollar Returns)
Indonesia
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
94 95 96 97
Vo
lati
lity
Indonesia
Volatility Contagion (S.D. of Monthly Dollar Returns)
9495
96
97
Indonesia
Korea
Brazil
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Indonesia
Korea
Brazil
Very Weak Relationship Between Beta (EM & world) and Mean Returns (volatilities do better)
7
Regression Of Returns On Country Variables
Var Coef t-Stat
Constant 0.009 0.068
Freedom
Index
0.004 0.106
GDP
Growth(%)
0.008 1.180
Rule of Law 0.026 2.240
IICCR -0.003 -1.507
EM Beta 0.016 0.431
World Beta 0.025 0.614
Volatility 0.718 1.868
R2(adjusted) 0.157
The volatility of market valuation FROM 1-4-88 TO 3-31-99 MONTHLY
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 19990
5
10
15
20
25
MEXICO-DS MARKET - DIVIDEND YIELDMEXICO-DS MARKET - PER
Source: DATASTREAM
The volatility of Interest rates FROM 1-4-94 TO 3-31-99 WEEKLY
1994 1995 1996 1997 1998 199910
20
30
40
50
60
70
80
90
100
MEXICO CETES 28 DAY CLOSING - MIDDLE RATEMEXICO CETES 2ND MKT. 360 DAY - MIDDLE RATE
Source: DATASTREAM
Lynch Ratio Sample of 45 comparable firms, 1998
0
5
10
15
20
25
30
Growth (%) P/E
0
0.2
0.4
0.6
0.8
1
Growth-to-P/E
Alternative Measurement of Emerging Market Risk:IICCR
Selective Country Ratings for EM Countries: They Are Highly Correlated.
What Determine Country Credit Ratings: CPI, GDP Per Capita, Market Cap, Growth.
Country Ratings Affect GDP Growth and Equity Returns. (Application: Cost of Capital Estimation in Project Finance)
Analysis of EM return, risk, and other factors:
9
bXay
The Relationship between Rule of Law vs. IICCR
0
20
40
60
80
100
0 2 4 6 8 10 12
Rule of law
IICC
R
Impact of Speculation on Market Volatility
Tulip Bulbs and the 1980s Speculative Craze
in Taiwan
Rocket Rise in Equity Market Prices
Frenzied Market Turnover
Little Attention on the Real Economy
Valuation Levels, Such P/E Ratios and
Dividend Yields, Can Help Spotting
Speculative Craze
TAIWAN SE WEIGHTED - PRICE INDEXFROM 1-1-87 TO 1-22-01 MONTHLY
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
000'S
0
2
4
6
8
10
12
14
Source: DATASTREAM
FROM 1-4-88 TO 3-31-99 MONTHLY
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 19990
10
20
30
40
50
60
70
80
90
TAIWAN-DS MARKET - DIVIDEND YIELDTAIWAN-DS MARKET - PER
HIGH 2.31 10-4-90 LOW 0.42 9-2-88 LAST 1.59HIGH 87.5 9-2-88 LOW 16.0 10-4-90 LAST 19.6 Source: DATASTREAM
PE and Dividend Yield at Historical Levels