The Performance of the Egyptian Stock Market_Bassam Azab

The Performance of the Egyptian Stock Market

Bassam I. Azab

Submitted in part fulfilment of the degree of Master of Business Administration,

International Banking and Finance

The University of Birmingham

The Birmingham Business School

September 2002

Acknowledgements

I would like to express my sincere gratitude to the following for their assistance

during the course of this study. Dr. John P. Cadle, my supervisor for his support

during the data collection process and for his academic views and comments during

the entire project and Professor Andrew W. Mullineux, Head of Master of Business

Administration, International Banking and Finance, The University of Birmingham

for his comments during the planning stage of this project.

I would like to thank the following for their valuable assistance during data collection,

which was of significant effect on the successful completion of this project. Dr.

Shahira Abdel Shahid, Director of Research & Markets Development, Cairo and

Alexandria Stock Exchanges. Khaled El Mahdy, Head of Research, HSBC

Investment Bank-Egypt. Amr A. Abol-Enein, Vice President and Head of Equity

Research, HC Brokerage. Hisham Hassan, General Manager, Prime Group. Georges

Cattan, Head of Custody and Clearing, HSBC Bank-Egypt. Yosra Fatin, Senior

Analyst, Research Department, HC Brokerage. Nirvana R. El Sherbiny, Supervisor

Custody and Clearing, HSBC Bank-Egypt and Wael I. Azab, Shawky and co.

I would like also to thank Jonathan A. Divis, General Manager, Operations and

Finance, HSBC Bank-Egypt for all his support, which led, eventually, to the

production of this work.

Finally, I would like to express my deep gratitude to the lady that was the reason

behind this work and all what I have managed to achieve so far, my mother. To her

and to my family I would like to say thank you.

To all the above, I would like to say Thank you for that, without your assistance and

support, the production of this work could not be possible.

Synopsis

Emerging markets are generally characterised by being informationally inefficient,

which might indicate the existence of mispricing opportunities that justify the

activities of active fund management to achieve abnormal returns within these

markets.

The aims of this project were, first, to explore the effect of information on the

performance of the stock market in Egypt in accordance with the Efficient Market

Hypothesis, as suggested by Fama (1970) and others, and, then, to assess whether

mutual funds in Egypt were able to adopt strategies that outperformed a passive

strategy.

To achieve these objectives, first, Event Studies were utilised to examine the

behaviour of stock returns around the announcement date of a number of corporate

actions including dividend distributions and acquisitions during the period 2000/2001.

Then, CAPM based Performance Evaluation measures were utilised to assess the

performance of a sample of mutual funds in the Egyptian market during the period

from the beginning of 1998 until the end of 2001.

The tests for market efficiency showed a departure from the Semi-Strong from

efficient markets indicating that publicly available information might have not been

fully reflected in securities prices and suggesting the existence of mispricing

opportunities that could have been used to achieve abnormal returns.

The tests for the performance of mutual funds showed that, despite the findings of the

tests for market efficiency, mutual funds in Egypt were unable to outperform a

passive market strategy.

Chapter 1 Introduction

Emerging markets are generally characterised by being inefficient due to their recent

history. This characterisation provides a number of perils and rewards to investors in

such markets.

Recent research, however, has shown many attractive rewards that, on the aggregate,

tend to over weigh the perils.

In this project, an attempt is made to explore the validity of the above statement by

modelling one of the new emerging markets that showed investment potential in the

Middle East and North Africa (MENA) region in the past few years.

The project attempts to investigate the degree of efficiency of the Egyptian market by

examining the effect of publicly available information on the performance of the

Egyptian stocks and whether profitable opportunities might exist to justify active fund

management activities.

The project, then, concludes by examining whether Egyptian mutual funds were able

to locate and benefit from these opportunities.

1.1. Aims and Objectives

Under the Efficient Markets Hypothesis, stock prices are assumed to Fully Reflect a

set of information so that, it becomes very difficult to gain abnormal returns by

trading on this set of information.

In this project, efficiency of the Egyptian market is examined with respect to the set of

publicly available information about the particular stocks analysed to see whether

stocks fully reflect the set of information, in the determination of their fair values, or

if mispricing opportunities exist and could be exploited to achieve abnormal returns.

The test is, then, directed to examining the performance of a sample of Egyptian

mutual funds to see whether they were successful in locating and profiting from

mispricing opportunities in the from of abnormal returns.

To achieve the above objectives, Event Studies, as suggested by Fama, Fisher, Jensen

and Roll (1969) are, first, utilised to examine the behaviour of stock returns around

the announcement date of various corporate actions (Dividend Distributions and

Acquisitions) during the years 2000/2001 to examine the effect of surprise, in the

form of new information, and the speed with which stock returns adjust to reflect the

new fair value of the stock.

Capital Asset Pricing Model (CAPM) based evaluation measures, as suggested by

Jensen (1968), Treynor (1965), Sharpe (1966) and Treynor and Black (1973) are,

then, utilised to evaluate the performance of a sample of mutual funds for the period

1998-2001 to assess their success in locating and profiting from mispricing

opportunities within the Egyptian market.

1.2. Project Structure

The project is structured in the following sequence:

Chapter 1 provides a general background, the Aims and Objectives of the project and

the Structure of the project.

Chapter 2 surveys the literature about Emerging Markets and Market Efficiency and

concludes by a study about the efficiency of the Egyptian market that was conducted

by the International Monetary Fund (IMF) in 1999 to test the Weak-form Efficiency

of the Egyptian market.

Chapter 3 provides a general preview about the Egyptian stock market including

Regulatory Framework, the Stock Exchange, Indices, Key Economic Sectors, Market

Participants and Instruments. The chapter concludes by an evaluation of the overall

performance of the market during the period 1996-2001.

Chapter 4 tests for Semi-strong market efficiency and is organised by, first,

identifying the Methodology of the tests, second, defining the Data set used and,

finally, providing the Findings of the tests of the behaviour of stock returns around the

announcement dates of a number of corporate actions (Dividend Distributions and

Acquisitions) that took place during the years 2000/2001.

Chapter 5 tests for mutual funds performance, and is organised, in a similar style to

that of chapter 4, by, first identifying the Methodology of the tests, second, defining

the Data set used and, finally, providing the Findings of the tests of mutual funds

performance during the period 1998-2001.

Chapter 6 concludes by summarising the Objectives and Procedures of the project,

providing the overall Findings and Conclusions about Market efficiency and mutual

funds performance, explaining the Limitations on the tests conducted, listing the

Recommendations based on findings and, finally, making Suggestions for Further

Research.

Chapter 2 Literature Review

2.1. Emerging Markets

It is usually difficult to classify markets into mature or emerging as there are no clear

dividing lines and grey areas always exist.

However, International Finance Corporation adopts two criteria to include countries

in its Emerging Markets Data Base (Solnik, 2000). These two criteria are:

A country with low or middle income using the World Banks

Classification;

A stock market that has shown the promise of becoming mature.

In his research, Solnik (2000) identifies the attractive attributes of Emerging Markets

as being of High Potential Growth and Low Correlation with developed markets. The

main concern that he identifies in his study is the relatively high volatility of

Emerging Markets when compared with Developed Markets.

In commenting on this concern, he draws attention to the fact that from a Portfolio

diversification point of view, the inclusion of Emerging Markets into the investment

portfolio provides a more efficient utilisation of the funds invested in terms of higher

returns for the same level of risk.

To substantiate his view, he includes the results of a study of the Efficient Frontiers

for global asset allocation with and without Emerging Stock Markets for a Swiss

Pension Fund (Odier, Solnik and Zucchinetti, 1995).

Graph (2.1) below depicts the results of the study.

Graph 2.1. Efficient Frontier with Emerging Markets

Source: Odier, Solnik, and Zucchinetti, Global Optimisation for Swiss Pension funds, 1995 in Solnik, Investments, 2000

From the graph, it can be seen that with a portfolio of 19% volatility, investment

solely in the Swiss stock market had a return of 11.5%; adding investments in

Developed markets only gave a return of 19% while the return increased to 28% when

both Developed and Emerging markets were included in the optimal portfolio.

In addition, Solnik (2000) details a number of benefits and concerns from an

international investors perspective with respect to investing in Emerging Markets.

The benefits listed include the interest of Institutional Investors in Emerging markets

interpreted in the form of professional studies, indices and better channelling of funds

for the best performing markets.

Economic benefits are another attractive factor in the form of lower labour costs,

lower levels of unionisation, social rigidities and rapid growth in domestic demand.

Political reform in many developing countries provides another factor why Emerging

markets are becoming more attractive. With the fall of communism in Central and

Eastern Europe, and the political reform in China, many developing countries are

adopting the model of a more free and open economy.

In his list of concerns, Solnik (2000) mentions concerns about Political and Social

Stability in developing countries. The highly diverse nature of Emerging Markets with

little correlation between them is another concern, which may lead to marked

differences in the performance of international indices. The availability of quality and

timely information is a very important concern with many Emerging markets lacking

reliable accounting and reporting standards. This is not to mention the lack of

harmony among those countries systems, which necessitates great effort to readjust

and harmonise if useful investment information is to be obtained.

Other concerns include the highly illiquid nature of emerging stock markets, since

trading in many of these markets is concentrated in a small number of stocks with

higher trading costs associated.

Two final concerns are the National Regulations and Controls, in the form of imposed

restrictions on foreign investment either on entry or exit, and the limited availability

of efficient Country Funds that can provide better specialisation and access to

Emerging markets for international investors.

Howell, Claessens and Gooptu (1994) go further by listing the benefits and concerns

for both countries and investors.

They suggest that, for Developing countries, the benefits of foreign investment flows

may be:

More diversified sources of external finance;

Greater risk bearing by private investors through equity investment,

compared to the case of bank lending in the 1970s;

Reduced cost of capital;

Better management of invested funds under the private-to-private flows.

They also suggest that the main concern of developing countries is that increased

capital inflows may lead to an appreciation of the real exchange rate, which may lead

to a bigger non-tradable sector, and a smaller tradable sector, and, eventually, to a

larger trade deficit.

They argue, however, that to overcome this problem, countries should rely on

sustained domestic economic reform. This comes in the form of a sound financial

system that properly channels inflows to the most appropriate uses.

They also list the benefits to investors from investing in Emerging markets as

including:

Favourable interest and equity return differentials with industrial countries;

Risk Diversification due to low correlation of stock returns in

developing countries with returns in industrial countries.

The inefficiency of Emerging markets, which makes returns predictable;

New channel for directing the continued domestic savings of industrial

countries.

In a manner similar to Solnik (2000), Howell et al. (1994) list concerns to investors as

being legal investment restrictions in the country of investment, poor credit ratings of

both the countries and the companies within, high and variable inflation, limited

market size, absence of solid regulatory and accounting framework and investor

protection, inefficient country funds and limited number of internationally listed

securities.

Williamson (1993) discusses the issue of better fund management under the private-

to-private flows and poses the question of whether foreign equity investment in

Emerging markets will necessarily lead to an increase in real investment in the private

sector.

He argues that most equity purchases are effected on the secondary rather than the

primary market. This has the impact of increasing share prices rather than increasing

investment flows to companies. Hence, the direct impact of increased flows may be

seen as increased wealth for investors in the secondary market, thereby increasing

consumption expenditure without an immediate benefit to the economy unlike the

impact a Foreign Direct Investment (FDI) might have.

However, he acknowledges the fact that with the continuing inflows of investment

funds to Emerging markets, a form of correction may take place in the shape of

increased investment due, perhaps, to sellers decision to invest the excess profits in

under-priced assets.

In a similar manner, Howell et al. (1994) present a Two-phase development of

emerging markets. In the first phase, which they designate Indiscriminate Capital

Flows, the prices of all assets rise due to the injection of foreign capital.

However, in the second phase, foreign investors start to search for genuine growth

industries in a manner that makes their buying behaviour introduces clear sectoral

patterns both between Emerging markets and within individual Emerging markets.

From the above Two-phase process described by Howell et al. (1994), it may be

inferred that the wealth of investors in the secondary market may increase in a manner

consistent with Williamsons views (1993) leading to increased consumption

expenditure.

However, the correction process should come in the second phase leading to an

effective channelling of foreign investment inflows to the benefit of the countries

involved.

Claessens (1993) presents another interesting barrier to investment in developing

countries; that is the restrictions, regulatory and accounting standards imposed on

investors in the home country. He explains that even if the country of investment has

no restrictions or barriers to the free flow of foreign funds, still any barriers, whether

regulatory or financial, imposed on investors in home country may prevent the free

flow of funds, for example, a ceiling on the investment in specific countrys market or

securities.

Claessens (1993) also discusses the concept of markets integration and explains that

integration moves in a reverse direction with diversification.

That is, if markets are fully integrated with each other, then the risk premiums will be

equal across markets and, hence, there will be no benefit from diversification.

He also explains that market integration is closely related to the level of barriers in the

market considered. So, the higher the barriers, the lower the market integration and

the higher the benefit of diversification.

From this argument, it may be inferred that the higher diversification benefit to

international portfolios, which is attributed to the low correlation between Emerging

markets and Mature markets, stems from the higher barriers to the free flow of funds

and may explain the recent increase in correlation between the performance of

Emerging markets and Mature markets. That is, with the continuing lowering of

barriers in Emerging markets, markets are getting closer to full integration with

developed markets and, hence, the diversification benefit from investing in those

markets diminishes.

Claessens (1993) also discusses another consequence of the existence of barriers in

Developing countries. That is, the security design which dictates how foreigners may

enter a specific market.

He depicts a typical case of a newly opened market to foreign investment where

access is initially restricted to specific types of instruments, Country Funds, etc.,

before direct and complete access is allowed to foreigners.

On the basis of this notion, he stresses the importance of proper security design,

which enables foreigners to access Emerging markets, whether under the conditions

of restricted access or free access to achieve the maximum benefit from investment.

He suggests three important factors to consider when designing the appropriate

securities. These are the degree of asymmetry of information about the specific

country or firm, characteristics of the borrowing firm and the depth and completeness

of securities markets.

Harvey (1993) examines another dimension of Emerging markets, the high volatility

exhibited by the markets of Developing countries. He argues that traditional models

that analysed the volatility Emerging markets were static models assuming risk

exposure to be constant over time.

He suggests that Emerging markets are characterised by Shifting Industrial

Structures, which suggests changes in risk sensitivities over time.

Stevenson (2001) confirms the drawback of the traditional Mean-Variance models of

analysing Emerging markets with the underlying assumption of Normal Distribution

of returns.

In this respect, he refers to the study by Bekaert, Erb, Harvey and Viskanta (1998)

which shows that Emerging equity markets display significant skewness and kurtosis

in their returns.

He also refers to the studies by Bekaert and Harvey (1995 and 1997), which show that

the degree of skewness and kurtosis for the distribution of Emerging markets returns

alter over time.

Table (2.1) shows summary statistical data for 23 Developed and 15 Emerging

Markets over the period 1988-1997 on a monthly basis.

Table 2.1. Summary Statistics for Emerging and Developed Markets

Table 2.1. Continued

Source: Stevenson, S. Emerging Markets, Downside Risk and The Asset Allocation Decision

The data is based on IFC indices for the Emerging markets and MSCI indices for the

Developed markets.

Table 2.1 shows that, with respect to Mean-Variance measures, Emerging markets

display more variations than Developed markets. This can be seen from the

comparison between the Average Monthly Returns for Developed markets, that vary

between 0.233% for Japan and 1.5037% for Netherlands, and the Returns for

Emerging markets, that vary between 0.7979% for Korea and 2.4731% for

Argentina.

Variance figures also show greater variation with Developed markets varying between

11.8745 for USA and 59.9113 for Hong Kong and developing markets varying

between 21.3601 for Jordan and 449.0278 for Argentina.

More interestingly, when considering the degree of skewness and kurtosis, most

Emerging markets returns display significant results indicating non-normality in the

distribution of returns.

For example, Nigeria shows significant values of kurtosis and skewness of 31.931 and

3.4479 respectively, compared to 0.4818 and 0.2368 for USA.

The Jarque-Bera (JB) statistics show similar results confirming the departure of Risk-

Return distribution of Emerging Markets from unconditional normality.

Therefore, Stevenson (2001) suggests that this should be considered when designing

the portfolio for an international investor.

Masters (2002) addresses another problem related to investment in Emerging

Markets, that is, the high costs associated with trading.

He classifies the costs into three categories: Management fees, Operating costs

such as custody, legal and accounting costs and Transaction-related costs, including

bid-ask spreads and brokerage commissions.

He also estimates the total investment cost to range between 2% and 5% of

investment value per annum with transaction-related costs being the highest

proportion. These can reach as high as 4% per annum.

To overcome this problem, he suggests a number of strategies to reduce the cost of

each category.

To reduce transaction-related costs, he suggests reducing turnover, using non-local

instruments such as ADRs - and calculating the after-cost returns when considering

alternative investment schemes in different Emerging markets.

To reduce operating costs, he draws attention to the scale effect of invested funds and

its effect on reducing the cost per dollar invested; as most operating costs are fixed in

nature.

Finally, to reduce management fees, he suggests that active fund management

techniques might be fruitful in emerging markets to generate more superior returns

that cover the high costs of management in these markets.

Saunders and Walter (2002) provide another update about emerging markets by

asserting that the correlations of returns between emerging markets and developed

ones have already increased over the past decade with many traditional barriers to

emerging markets being removed with the overwhelming trend of economic reform

among developing countries. (Table 2.2)

Table 2.2. Correlations in Returns between Emerging and Developed Markets

Source: Saunders and Walter, Are Emerging Market Equities a Separate Asset Class, 2002

They conclude that the traditional consideration of emerging markets stocks as being

a separate asset class and, therefore, allocation of funds among countries indices will

no longer be sufficient to generate diversification benefits.

Instead, they confirm Masters suggestion (2002) that the role of active fund

management in exploring market inefficiencies and properly selecting securities and

sectors within these markets will be highly crucial in the future if superior returns are

to be achieved.

The above review of literature about investment in Emerging Markets shows that

Emerging markets tend to exhibit attractive characteristics for international investors

in terms of portfolio diversification due to the high returns and the low correlation

with mature markets. However, barriers to entry and the high volatility of Emerging

markets are major issues that must be taken into account in the investment decision.

Another important aspect is the recent tendency of Emerging markets to be more

integrated with World markets and, thereby, the diminishing benefit of diversification

to the international investors.

2.2. Market Efficiency

Early formal research about Market Efficiency dates back to the 1950s. Ever since,

the concept of Market Efficiency gained a lot of interest and popularity that the

literature now is so vast and impossible to include in a single review as correctly

indicated by Fama (1991, pp. 1575):

The literature is now so large that a full review is impossible.

Therefore, the main work about Market Efficiency, especially that of particular

interest to the purpose of this research, is included.

Many researches consider the work of Maurice Kendall to be the forerunner of the

studies about Market Efficiency.

In his research, Kendall (1953) examined the behaviour of weekly changes in 19

indices of British industrial share prices and in spot prices for cotton (New York) and

in Wheat (Chicago). His conclusions after extensive analysis of serial correlations is

that the stock prices follow a Random Walk, that is, stock returns tend to be

independent of past returns. (Fama, 1970)

The first impression of Kendalls conclusion is that markets are irrational and tend to

act with no sense of direction.

Later research clarified that Kendalls conclusion, in fact, reflects the rational nature

of the market.

Fama (1970) defines an Efficient Market as one where information is Fully

Reflected in stock prices. That is, investors use the available information about the

stock to determine its fair value. Thus, any information available, or predictable,

about the stock performance would have already been included in the stock price.

Stock price changes will only result form the arrival of new information in the form of

surprises to the market. As new information arrives randomly, so the price changes

will occur randomly.

So, to have an efficient market, the stock prices must Fully Reflect the information

set available , which is the basis for classifying the markets.

In this respect, Fama (1970) identifies three types of markets based on three different

sets of information:

Weak-form efficient, where the prices reflect all available information

about past prices;

Semi-strong-form efficient, where the prices reflect all publicly

available information, including earnings, companies performance,

etc.;

Strong-form efficient, where the prices reflect all information, public

and private, available to investors.

In addition, Fama (1970) departs from the earlier assumption that securities prices

follow a random walk and suggests that they tend to follow a Submartingale.

That is, instead of the restrictive assumption that securities prices, and returns, are

serially independent and identically distributed, he assumes that prices follow a

Random Walk with a Drift so that, on the long run, securities returns tend to move

upward; indicating a positive long-term return.

Consequently, Fama (1970) argues that if stock prices follow the above mentioned

pattern, a Submartingale, then no trading rule based on the information set can

outperform a Buy-and-Hold strategy.

Subsequent research found relatively supporting evidence to Famas hypothesis.

For example, Conrad and Kaul (1988) examined the weekly returns of NYSE stocks

and found relatively small positive serial correlation over short horizons.

This type of research provided support to proponents of Efficient Market Hypothesis.

However, the hypothesis was not free from criticism.

Poterba and Sumers (1988) and Fama and French (1988) found that over longer

horizons, stock prices returns show negative long-term serial correlations suggesting

that stock prices might overreact to relevant news in whats came to be known as the

Fads Hypothesis (Bodie, Kane and Marcus, 2001)

Also, Leroy (1989) challenged Famas argument (1970) that when prices follow a

submartingale, no strategy can outperform a Buy-and-Hold strategy.

He mentioned two reasons to support his argument. First, that Fama did not provide

any supporting evidence for his claim and that, it is easy to provide examples of

markets in which the prices follow a submartingale and, yet, there exist trading rules

that outperform a Buy-and-Hold strategy.

Second, that the Capital Asset Pricing Model (CAPM) implies that, in equilibrium,

asset returns will not necessarily follow a submartingale. That is, a stocks returns

might negatively co-varies with the market strong enough that it would be included in

a risk averse investors portfolio simply to limit the degree of risk exposure.

LeRoy (1989) also pinpointed another drawback of the Martingale Model that Fama

(1970) assumed securities prices to follow. That is, the Martingale model assumes

Risk Neutrality and that investors will rush to buy/sell mispriced securities without

consideration to the level of risk exposure this might put them in.

LeRoy (1989) argues that this contradicts with the general notion that investors are,

generally, risk averse and that the level of risk exposure is an important aspect in their

portfolio formation.

In comment on these arguments, Fama (1991) explained that a central assumption in

the volatility tests of his earlier work was that expected returns were constant and that

the variation in stock prices were caused, entirely, by shocks in expected dividends.

He acknowledged the usefulness of volatility tests to show that expected returns vary

through time; however, he argued that these tests, in themselves, do not help in testing

whether the variations in expected returns are rational.

He also mentioned another problem associated with these findings, that most of the

research faced a Joint Hypothesis problem where tests were joint tests of efficiency

and the validity of the model used.

Fama (1998) added three reasons to why the detected anomalies that indicate

overreaction, or underreaction, over long-term do not invalidate the Efficient Market

hypothesis: first, that the literature does not provide a random sample of events;

second, that some apparent anomalies may be generated by rational asset pricing due

to changes in volatility; and third, that most anomalies tend to disappear when

reasonable alternative approaches are used to measure them.

Another recent opposing study attempted to provide new insights into the debate that

markets might not be efficient at all times.

Lewellen and Shanken (2002), argue that the true data generating process might

enable the econometrician to uncover certain patterns in prices and returns that might

either be not perceived, or not exploited by investors even when investors fully utilise

all available information.

This, they argue, is due to Parameter Uncertainty, where investors assume that

prices of securities follow a martingale.

This assumption by investors implies that dividend distribution, which they consider

as the crucial cause for price changes, is random with a random mean.

They argue, however, that empirical studies show that prices tend to converge, over

time, to their true fundamental values. This implies that dividend distribution is not

completely random and that, in fact, has a constant mean.

They conclude that, as investors benefit from the learning process when uncertainties

are eliminated, they tend to act in such a way that drives prices to correct (in a mean-

reversion process).

Something, they comment, which data generating process can predict before hands.

The above review shows that debate about market efficiency is likely to continue with

proponents asserting that markets, on the average, are informationally efficient, while

opponents continue to provide new evidence about market inefficiency and the

possibility of locating opportunities to achieve abnormal returns.

In the mean time, the Efficient Market hypothesis remains a significant area of

interest and its significance increases when Emerging Markets are considered in the

search for exploitable opportunities within these markets.

Mecagni and Sourial (1999) examined the Market Efficiency within the Egyptian

market. Analysis of Egyptian stock returns were conducted using Four daily aggregate

indices which are widely used within the Egyptian market, namely, the Capital

Market Authority Index (CMAI), the Egyptian Financial Group Index (EFGI), the

HERMES Financial Index (HFI) and the Prime Initial Public Offerings Index

(PIPO). A detailed description of the various indices is given in chapter 3.

The test sample consisted of 828 daily observations on stock returns form 1st

September 1994 until end-December 1997 and the analysis were conducted using a

Generalised Auto-Regressive Conditional Heteroscedasticity model (GARCH).

Table 2.3 below shows the main results of the study.

Table 2.3. Unconditional Distribution Statistics for the Egyptian Stock Exchange Daily Stock Returns

Source: Mecagni and Sourial, The Egyptian Stock Market: Efficiency Tests and Volatility Effects, 1999

From the table, it can be seen that Mean Returns for privatised companies (PIPO) is

double that for all stocks (CMAI) and highly liquid stocks (HFI) and significantly

higher than that for large capitalisation stocks (EFGI).

Also, Variability (as represented by Standard Deviation) is approximately the same

for (EFGI), (HFI) and (PIPO) but significantly less for (CMAI) reflecting infrequent

trading of many listed stocks.

In addition, returns exhibit positive skewness and excess kurtosis for all indices. An

observation that confirms the conclusions of Bekaert et al. (1995, 1997 and 1998) and

of Stevenson (2001) about the distribution of returns in Emerging Markets.

Mecagni and Sourial (1999), conclude that returns display a degree of time

dependence and volatility clustering. This suggests serial correlation of returns, which

can be used to achieve a degree of predictability based on past returns and, therefore,

implies a departure from the Efficient Market Hypothesis.

In the following chapters, the attempt will be made to provide an update on the market

efficiency of the Egyptian Stock market in the light of the recent improvements and

reform activities.

Chapter 3 General Preview

3.1. Egyptian Stock Market

Formal Stock market activity in Egypt dates back to 1888 when the Alexandria Stock

Exchange was inaugurated. The Cairo Stock Exchange was established in 1903.

Trading was very active during the 1940s, with the Egyptian Exchange ranking Fifth

most active in the world during that period.

However, due to the Socialist policies adopted by the government, which led to a

major nationalisation program that started in 1959, a drastic reduction in activity

occurred from 1961 till 1991. The two exchanges remained operating during that

period but trading on the floor was effectively dormant.

In 1990/1991, the government started its major economic reform program towards

free market mechanism and privatisation. One of the major dimensions of this

program was the revival of the Capital market through the enactment of the Capital

Market Law No. 95/1992. The law provided great momentum to the market and the

market capitalisation increased dramatically as the reform and privatisation

progressed.

Table (3.1) provides main market indicators for the Egyptian Stock Market for the

period 1991 June 2001.

Table 3.1. Main Market Indicators for the period 1991 June 2001

Source: Cairo and Alexandria Stock Exchanges Fact Book, 2001

From the table, it can be seen that the market capitalisation increased form L.E.8.8

billion in 1991 to L.E. 119.7 billion in 2000 and was slightly reduced to L.E.110.3

billion by the end of June 2001. Also, the number of listed companies increased from

627 in 1991 to 1070 by the end of June 2001.

Volume and value of traded securities also increased dramatically as can be seen from

Graph (3.1) and (3.2), which correspond to lines 3 and 6 of Table (3.1) respectively.

Graph 3.1. Total Volume of Traded Securities Graph 3.2. Total Value Traded of Securities (Million), Jan. 1991 Jun. 2001 (Million), Jan. 1991 June 2001

Source: Cairo and Alexandria Stock Exchanges Fact Book, 2001

The Egyptian Stock Market is well regulated, however, theres still limited depth.

While there are 1070 companies listed, trading is concentrated in less than 100

companies with the majority of trading volume and value in about 30 companies.

Table (3.2) below shows that, as at 30 June 2001, 82.26% of market liquidity was

concentrated in 30 stocks.

The table indicates that despite the increased market capitalisation of the Egyptian

Stock Market, trades remain concentrated in a few companies that exhibit real strong

fundamentals.

Table 3.2. Liquidity of the 30 Most Heavily Traded Stocks in Terms of Value Traded (Jan. 2001 30 June 2001)

Source: Cairo and Alexandria Stock Exchanges Statistical Highlights, 2001

3.1.1. Regulatory Framework

The Egyptian stock Market is well regulated, currently having a number of legislation

that govern the establishment and operation of companies within the market.

The laws that govern the Egyptian Stock Market operations are:

The Capital Market Law (Law 95/1992)

Replacing Law 161/1957, the Capital Market Law came into effect in 1992. This law

provided the main regulatory framework for the activities of the stock market by

recognising primary and secondary markets, the organisation of the market

participants, listed companies and stockbrokers, the provision of a modern mechanism

for trading and investment through the market and the exemptions and incentives to

boost the market and provide its depth.

One of the main advantages of the law was the recognition of the central role of the

Capital Market Authority (CMA) and the powers it was given by the law to organise

and control the market. Following the enactment of the law, the Capital Market

authority played and important role in modernising the market through authorising

listed companies and brokerage firms and the monitoring function over the activities

of the exchanges towards more transparency and fair dealings.

The Central Depository Law (Law 93/2000)

This laws aims to provide the legal framework for the Central Depository in Egypt.

The law identifies shareholders rights and their legal ownership, which are stated to

pass from the seller to the buyer of securities when the trade is actually cleared and

settled at the stock exchange on settlement date.

The law also recognises foreign ownership rights, which are the same as those of

Egyptian shareholders, and provides mechanism for membership and operation of

organisations carrying out bookkeeping activities either for themselves or on behalf of

their clients.

The law also introduced the legal recognition of the concept of Nominee Trading

and the Depositorys obligation to establish and control a Guarantee Fund which

ensures the settlement of trades on time to achieve smooth market operation.

The Companies Law (Law 159/1981)

This law provides the framework for the establishment and operation of companies

within the Arab Republic of Egypt.

The law covers the main establishment procedures, the management and control

responsibilities, the extent of liability of owners, the required accounting and financial

control procedures and all other aspects that a company may encounter in the course

of its business.

The Privatisation Law (Law 203/1991)

This law is the basic legislation for the development of the privatisation program and

encouragement of economic reform.

The main aim of the law was to transfer the Government-owned authorities into self-

run Holding Companies under which Public Sector companies can be given greater

flexibility to operate its business activities away from the central government control.

(As per explanatory memorandum attached to the law by The Prime Minister)

The law is considered a transitory phase to provide the public sector firms with the

mechanism to restructure so as to become attractive candidates for privatisation.

This law regulates companies in which the government possesses 51% or more of its

shares. When the governments share of ownership in a company drops to less than

51%, the regulation of the company passes from law 203 to law 159.

The Investment Law (Law 8/1997)

This law was enacted to encourage direct and indirect investment in certain industries

and sectors of the economy.

The law provides tax exemptions, guarantees against asset expropriation, attractive

custom tariffs and freedom from price controls.

In addition to the above legislation, the Cairo and Alexandria Stock Exchanges

(CASE), in liaison with the Capital Market Authority set a number of Listing Rules

for companies wishing to be listed and traded on the exchange. Appendix A details

the existing Listing Rules as well as the proposed new Listing Rules which are

expected to come into effect later in 2002 with the aim of increasing transparency,

efficiency of information dissemination and corporate governance of the companies

listed.

3.1.2. The Exchange

Egypts Stock Exchange has two locations: the main location is in Cairo and the other

one is in Alexandria. Both exchanges are managed by the same Chairman and Board

of Directors and are commonly referred to as the Cairo and Alexandria Stock

Exchanges. (Cairo and Alexandria Stock Exchanges Fact Book, 2001)

The Chairman of the Exchange is appointed by the government. The Board of

Directors includes directors elected from market participants as well as nominated

representatives of the Capital Market Authority (CMA), the Central Bank of Egypt

(CBE) and the Banking sector. In addition, there are three non-voting members.

The trading system in the exchange evolved from an open outcry system prior to 1992

to the existing fully automated, order-driven system. The existing system incorporates

trading, clearing and settlement of trades with an automated link to the Central

Depository. The system also provides automatic mechanism for market surveillance

for better market performance. (CASEFB, 2001)

The exchange is regulated by the Capital Market Law (Law 95/1992) and sets, in

conjunction with the Capital Market Authority (CMA), the listing rules for

companies.

Currently, companies can be listed on either the Official Schedule or Unofficial

Schedules (1) and (2).

Although the listing requirements for the Official Schedule and Unofficial Schedule

(1) are similar, the requirements of the Official Schedule are more stringent.

To be listed on the Official Schedule, companies must have at least 150 shareholders

and offer, at least, 30% of their shares to the public or be one of the companies

regulated under Law 203.

Companies not qualifying for the requirements of the Official Schedule can be listed

on the Unofficial Schedule (1).

Unofficial Schedule (2) was introduced in February 1998 to cater for new companies,

which cannot, at their initial stage, satisfy the more rigorous requirements of the

Official Schedule and Unofficial Schedule (1).

By the end of June 2001, 141 companies were listed on the Official Schedule and 929

companies on Unofficial Schedules, of which 229 companies were listed on

Unofficial Schedule (2). (CASEFB, 2001)

3.1.3. Indices

There are a number of indices that serve as Benchmarks for the Egyptian market.

For local investors, the following indices are usually followed:

The Capital Market Authority Index (CMAI)

Started on 2nd January 1992, the index includes all listed stocks weighted in relation to

their market capitalisation. It can be viewed as an All-Share index that covers the

broadest base of stocks. (Mecagni and Sourial, 1999)

Cairo and Alexandria Stock Exchanges 50 Index (CASE50)

Started on 2nd January 2000, the index tracks the performance of the most active 50

stocks. Currently there are two versions of the index, the (CASE50 Price Index),

which measures the return on investment from the change in value of the stocks. The

second version is the (CASE50 Total Return Index), which measures the return on

investment form both income from dividend and capital gains.

Both indices are market capitalisation weighted and the constituents are reviewed

semi-annually. (CASEFB, 2001)

In addition, a number of companies are calculating their own indices and those

include:

HERMES Financial Index, (HFI)

Started on 2nd January 1993, the index tracks the performance of a number of active

companies in the market with a minimum of three months active trading history. The

index is market capitalisation weighted and revised quarterly. (Mecagni and Sourial,

1999)

As at June 2001, the index included 48 companies. (CASEFB, 2001)

Egyptian Financial Group Index (EFGI)

Started on 2nd January 1993, the index tracks the performance of a subset of the

HERMES Financial (HFI). The index tracks the performance of listed Large

Capitalisation stocks with minimum L.E.300 million in market capitalisation and the

constituents are revised quarterly. (Mecagni and Sourial, 1999)

As at June 2001, the index included 23 companies. (CASEFB, 2001)

Other companies also calculate their own indices including, Prime that calculates

(Prime Initial Public Offerings PIPO), (Prime Asset Management Index PAMI)

and (Prime General Index PGI).

The first is a price index that tracks the performance of companies, which were

offered to the public through Initial Public Offerings (IPOs). As at December 2001,

the number of companies included was 67 companies. (Prime Research, 2001)

The second index tracks the performance of Large Capitalisation companies. As at

December 2001, the number of companies included was 18 companies. (Prime

Quarterly Review, Dec. 2001)

The last one is a general index, which tracks the performance of a wide range of

active companies. As at March 2002, the number of stocks included was 32. (Prime

News Flash, March 2002)

Beside Local indices, and due to the foreign interest in Egyptian equities, Egypt was

included in the International Finance Corporations Global and Investable indices

(IFCG and IFCI) in 1996. Egypt was added to the Morgan Stanley index on a stand-

alone basis in 1997.

In May 2001, Egypt was included in the Morgan Staley Emerging Markets Free

(EMF), (EMEA, excluding South Africa) and All Country World Index (ACWIF) at

weights of 0.28%, 2.12% and 0.14% respectively. (CASEFB, 2001)

3.1.4. Key Economic Sectors

Egypts success in implementing sound economic policies, the acceleration of the

privatisation process and liberalization of trade are reflected in the healthy economic

indicators that Egypt enjoys.

Table (3.3) below depicts the main economic indicators for Egypt for the period 1997

till 2000.

Table 3.3. Main Economic Indicators 1997 - 2000

Source: HSBC Investment Bank Egypt, Treasury and Capital Markets: A Guide to Egypt, 2001

Table (3.3) shows GDP growth rate of 5.1% in 1999/2000, down from 6.1% in

1998/1999 due to the economic slowdown, which was a reflection of the global

economic conditions.

Egypts inflation rate has also declined from 3.8% in 1998/1999 to 2.8% in 1999/2000

with an average rate below 4% for the entire period from 1997 2000.

Foreign Reserves have declined from US$ 20.3 billion in 1997/1998 to US$ 14.7

billion in 1999/2000 due to the governments managed float, foreign exchange policy.

However, the level of reserves remains healthy covering approximately 9 months of

imports.

Exports increased by 42% in 1999/2000 while imports have shown a steady growth at

approximately 5%.

Perhaps the major challenge for the Egyptian government is the level of

unemployment, which is worsening with the persistent growth in population. This has

been indicated by the government as one of the major priorities in several statements

by both the President and the Prime Minister.

In the following lines a brief description of the key economic sectors that contribute to

economic and business development are described.

Banking

The banking sector is one of the well-established sectors in the economy with the first

bank in Egypt dating back to the 1920s.

The banking sector in Egypt consists of the Central Bank of Egypt (CBE), which is

the governing body, 24 Commercial and Joint-Venture banks, 11 Investment banks, 3

Specialised banks and 15 branches of Foreign banks. (HSBC, 2001)

The Central Bank of Egypt was established in 1960 and its main responsibilities

include formulating the monetary, credit and banking policy, the issuance of bank

notes, management of the states reserves, control of banks, and the management of

public debt on behalf of the government.

Commercial banks possess a dominant role in the financial sector in Egypt with 4

Public Sector and 5 Private sector banks dominating the banking activities.

Public sector banks control approximately 53% of banking total assets and 60% of

total deposits. However, Private sector banks outperform Public sector banks in terms

of profitability. (CASEFB, 2001)

There are currently 11 Investment banks in Egypt providing a range of services

including Corporate Finance, Advisory, Securities, Debt and Equity Capital

Management, Project and Export Finance and Asset Management Services. (HSBC,

2001)

There are 3 Specialised banks in Egypt. The Egyptian Arab Land Bank extends loans

to the housing, building and land sector. The Industrial Development bank finances

the industries and the Principal Bank for Development and Agricultural Credit

finances the agricultural sector in Egypt. (HSBC, 2001)

Following the 1996 Banking and Credit law, a lot of deregulation has occurred in the

banking sector with fixed commission and Reserve requirement on time deposits

exceeding 3 years (15%) effectively abolished.

The law also allowed 100% foreign ownership of local banks but Central Bank of

Egypts approval is required before any acquisition exceeding 10% of capital.

(CASEFB, 2001)

Tourism

Tourism receipts account for approximately 5% of GDP and is one of the major

contributors to the governments revenue.

Two of the major problems that affect the industry are the Instability of flows and the

poor infrastructure and marketing.

Realising these problems, both the government and private sector have taken several

steps to boost the sector by developing the facilities and undertaking proper marketing

campaigns. Most of the recent developments in the facilities took place in Sinai and

the Red Sea coast.

Year 2000 witnessed an increase in both the number of tourists, with 5.5 million

arrivals, and revenues, which increased by 33% to US$ 4.7 billion. (CASEFB, 2001)

Cement

Cement is one of the most active and profitable sectors. This sector has witnessed a

boom during the 1990s. During the period 1993-1999, the sector grew at an average

10.9%. This was in direct relation to an average growth in GDP of 5% per annum and

an average growth in construction industry of 2.5% per annum. (HC, 2001)

With strong local demand exceeding supply, producers were able to operate at very

high profit margins. As a result, a wave of foreign interest in the Egyptian cement

sector spurred in the form of major acquisitions in Egyptian companies.

Table (3.4) below shows the current market share of three of the largest cement

producers in Egypt as of 2001.

Table 3.4. Market Share of the Three Largest Cement Producers in Egypt, (2001)

Source: HC Brokerage, Egypt: Equity Research, 2001

As a result, capacity additions rose by 10.2% in 2000 and by 28.7% in 2001. This

increase in capacity, coupled with the economic slowdown and stagnation in

construction industry in 2000/2001, resulted in supply exceeding demand for the first

time in 2001/2002. (HC, 2001)

As the Egyptian economic slowdown was a reflection of a global recession, exports

did not benefit from the excess supply and producers had to reduce the production

levels and sell at fairly lower prices.

However, it is expected that once the global recession comes to an end, and with the

expected new tranches of Public Sector companies offered for privatisation, the sector

will regain its momentum and offer attractive opportunities for investors.

Telecommunications

The telecommunications sector in Egypt is one of the promising sectors offering a

great potential for development and growth.

The sector is currently divided into fixed Land Lines and Cellular markets. Both

markets are regulated by the Telecommunications Regulator Authority (TRA), which

oversees the quality and regulates the pricing of services provided.

Currently, the fixed Land Line market serves 6 million subscribers and the Cellular

market consists of two Mobile services companies that serve over 2.5 million

subscribers. It is expected that by 2003, when the exclusivity period for the existing

two companies ends, other companies will be allowed into the market and this should

increase competition and enhance the quality even further. (CASEFB, 2001)

Finally, with less than 8% penetration for fixed Land Lines and 2% penetration of

Mobile Phone services, the Egyptian market is still under serviced offering great

opportunities for investment. (CASEFB, 2001)

Energy

This sector is comprised of Petroleum, Natural Gas and Electricity. It is one of the

most important sectors in the Egyptian Economy and contributes approximately 6%

of GDP.

Petroleum is one of the major sources of foreign currency and represents

approximately 40% of export revenues. Annual production is around 30 million tons

while consumption is around 20 million tons with the surplus being exported.

Approximately 79% of Egypts oil comes from the Gulf of Suez and Sinai with new

excavations indicating reserves in both the Eastern and Western deserts.

Natural Gas is increasingly replacing oil products in Egypt with reserves of

approximately 50 billion cubic feet of high quality gas.

With these huge reserves, the government aims to encourage switching into gas

products and to export liquefied gas to provide another source of foreign currency.

Electricity sector contributes approximately 2% of Egypts GDP. Sources of

electricity include 20% from hydroelectric generation, 53% from gas-fired steam

plants and 26% from cycle plants.

Currently, domestic consumption is around 57 billion KWH, with demand increasing

about 7% per annum.

Electricity is currently under state control, however, it is expected that the government

will start offering a tranche of two of the major companies, namely Greater Cairo and

Canal Electricity companies, for privatisation. (CASEFB, 2001)

3.1.5. Market Participants

As at June 2001, there were 146 brokerage firms operating in Cairo and Alexandria.

The top 30 brokers represented more than 70% of the traded value in 2001 with the

remaining brokerages representing the remaining 30%. (CASEFB, 2001)

Brokerage firms may be 100% foreign owned, but the Chief Dealer must be a locally

experienced market professional. (HSBC, 2001)

Under the Capital Market Law, the Capital Market Authority (CMA) is the licensing

agency for both listed companies and brokerage firms.

Previously, the (CMA) requirements was that a brokerage firm must have a minimum

Authorised Capital of L.E. 1.5 million. However, the more recently introduced Capital

Adequacy requirements mandate that new brokerage firms must have a minimum

Authorised Capital of L.E. 5 million. New brokerage firms are also required to have a

minimum of 10 operating branches spread all over Egypt. (HSBC, 2001)

These more stringent requirements were introduced in an attempt to rationalise the

number of brokerage firms offering their services in the market and, thereby,

improving the quality of services rendered.

As at June 2001, 22 local funds (19 Open-end and 3 Closed-end) and 10 Offshore

funds were operating in the market.

In addition, there were 31 Portfolio Management firms, 29 Underwriters, 11 Venture

Capital firms and 6 rating companies operating in the Egyptian market. (CASEFB,

2001)

3.1.6. Instruments

Equities are the main instrument in the market, which provide the bulk of trading.

Since 1998, the issues offered in the secondary market have increased in terms of

diversity and volume. One main reason for the development of the market was the

government commitment towards the privatisation program by offering new firms to

the public.

Fixed income market has witnessed rapid expansion with the government introducing

several issues of Housing and Treasury bonds with maturities ranging from 7-10 years

ever since 1998. Private sector companies have also taken the authorisation granted to

them by the Capital Market Law and started issuing Corporate Bonds to diversify

their financing to other sources than banking finance.

However, the secondary market in bonds is still largely inactive compared to the

equities market. This can be seen from the market capitalisation for both Government

and Corporate bonds of L.E. 17.9 billion in June 2001 as compared to L.E. 110.3

billion for equities. (CASEFB, 2001)

Depository Receipts provide another type of instruments for the market. As of June

2001, Nine Egyptian companies had their shares traded in the form of Global

Depository Receipts on the London Stock Exchange. Of these nine companies, Three

are also listed on Frankfurt Stock Exchange and One is listed on the Luxembourg

Stock Exchange.

Several Egyptian companies are currently studying the possibility of issuing

American Depository Receipts in the American market. (CASEFB, 2001)

From the above review, it can be seen that the Egyptian market has undertaken

several measures both in terms of regulation and performance to ensure lower barriers

and better quality for local and international investors.

However, concentration and lack of depth, in terms of the types of instruments

available, are still material issues that affect the market performance and should be

handled effectively if the market is to improve its efficiency.

3.2. Market Performance

Market analysis for the period 1996 till 1st quarter 2000 is based on the analysis included in EFG-Hermes: Country Report, May 2000. Additional analysis for the period 2nd quarter 2000 till 2001 is based on the analysis included in Cairo and Alexandria Stock Exchanges Fact Book, 2001 Performance analysis is based on the performance of the Hermes Financial Index for the period 1996-2001.

Despite the fact that the Capital Market Law (Law 95/1992) gave the regulatory

power to reform the Stock Market in Egypt, it wasnt until 1996 when Nasr City for

Housing and Development Company offered the first majority privatisation stake in

accordance with the aims and objectives of the Privatisation Law (Law 203/1991).

Ever since, the market dynamics changed and the market started a sharp climb with

the Hermes Financial Index ending the year 1996 with a gain of 43% most of it within

the second half of the year (Graph 3.3).

Graph 3.3. Overall Market Performance, (1996 1998)

Source: EFG-Hermes, Egypt: Country Report, 2000

This momentum continued in the early months of 1997 when the market reached its

all-time peak on 27 February 1997. However, the sharp rise was based on weak

market fundamentals and a downward trend took place for the rest of 1997 and most

of 1998.

In the mean time, and during 1998, the market started shifting from traditional Value

Stocks to new-economy Growth Stocks when the private sector started offering

major issues in the market.

The market ended the year 1998 down by approximately 26% and despite the 27%

loss on public sector equities, private sector equities ended the year with a 36% gain

(Graph 3.4)

Graph 3.4. Private versus Public Sector Share Performance, 1998


In early 1999, the market started rising once again. This was mainly attributed to the

initial public offering of Mobinil, the first in telecommunication sector, which

marked the market shift towards more sophistication in trading decisions with

Mobinils share price ending 1999 with 660% increase.

In the mean time, a liquidity squeeze became apparent amid concerns about the

governments management of the economy and its commitment to the privatisation

programme. This drove the market down for the most of 1999. (Graph 3.5)

Graph 3.5. Market Performance, (1998-1999)


In October 1999, a cabinet change was declared and the market immediately reflected

its anticipation about the declared change in the form of a market rise that took place

in the last quarter of 1999 and continued in the 1st quarter of 2000.

During the 1st quarter of 2000, a wave of consolidations took place both in the Cement

and Banking sectors with offers from local and foreign investors driving share prices

up, particularly in the Cement sector.

However, with liquidity tied up in Cement shares, other stocks started suffering,

which led, eventually, to the market drop by mid. February 2000. (Graph 3.6)

Graph 3.6. Market Performance, (2000 2001)

0

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HFI

Source: REUTERS / EFG-Hermes

The general downturn continued during the rest of 2000 and throughout 2001 with the

market being down by 59.6% from early 2000. This was mainly attributed to the

global downturn, the slow pace of privatisation and the political circumstances in the

Middle East Region.

In this respect, Egypt was no exception of other emerging markets that lost substantial

amount of their value during the same period mainly due to the global economic

slowdown.

Chapter 4 Market Efficiency

4.1. Methodology

4.1.1. Event studies

The approach adopted in testing for market efficiency within the Egyptian Stock

market is Event Studies as suggested by Fama, Fisher, Jensen and Roll (1969).

In this approach, stock returns are examined around the date new information about

the performance (or prospects) of a company is announced. The speed of response of

the stock returns to the new publicly available information indicates the degree of

efficiency.

Thus, if securities returns adjust immediately to new information, this will be an

indication of an overall Semi-strong, efficient market.

If, on the contrary, securities returns respond slowly, thereby allowing the uninformed

investor to achieve abnormal returns by simply observing the price behaviour without

any additional fundamental analysis, this will be an indication of an overall Semi-

strong, inefficient market.

The tests were conducted using an Ordinary Least Squares regression model (OLS) to

identify the stocks Expected Normal Returns and, hence, any deviation of Actual

Returns from Expected returns in the form of Unexpected Abnormal Returns.

Mathematically, the returns of a security can be represented by the following formula:

ri = i + irM + ei (4.1)

Where, ri is the return on security i, i is the initial return (the return on security i

when the market return is zero), i is the sensitivity of the returns of security i to

market returns, rM is the market return (the return on a benchmark index representing

the market portfolio), and ei is the deviation of the actual returns of security i from

expected returns, also known as security is abnormal returns

From equation (4.1), the abnormal returns of a security can be found be rewriting the

equation to be:

ei = ri (i + irM) (4.2)

Equation (4.2) will be the basis for calculating Abnormal Returns throughout the

analysis.

In order to avoid problems associated with equilibrium models when measuring

returns (Fama, 1998), the following procedure was adopted:

using Cumulative Abnormal Returns (CAR) to measure abnormal

returns surrounding the event examined instead of the Buy-and-Hold

Average Returns (BHAR) method;

returns were measured over short horizons to provide better results

under the assumption of securities returns being normally distributed.

This helps avoiding the problem of skewness of returns that characterises the stock

returns in Emerging markets (Bekaert et al., 1995, 1997 and 1998) and (Stevenson,

2001).

4.1.2. Beta Calculation

The benchmark, relative to which the sensitivities of securities returns were measured,

is the Herms Financial Index (HFI).

The choice of index was due to its mature nature (inception, 2nd January 1993) and its

wide scope that includes the highly traded companies, which provides a more reliable

proxy for the market.

The calculation was based on the weekly returns of the index for the period from the

beginning of January 1998 until the end of December 1999.

In the calculation, it was assumed that the value of Beta has been constant for the

period 1st January 1998 till 31st December 1999 and that this value was different from

that of prior periods.

Table 4.1 shows the values of Standard Deviation, Skewness and Kutosis for the

index returns for the periods 1996/1997, 1998/1999 and 2000/2001.

Table 4.1. Key Statistics for the Hermes Financial Index, 1996-2001

Date Index Value Change Index Returns Date Index Value Change Index Returns Date Index Value Change Index Returns 1996-19971 1998-1999 2000-2001 (Vt / Vt-1) ln (Vt / Vt-1) (Vt / Vt-1) ln (Vt / Vt-1) (Vt / Vt-1) ln (Vt / Vt-1) % % %

10/11/1996 8676.70 28/12/1997 12260.70 26/12/1999 12152.40 17/11/1996 8828.71 1.017519 1.74 04/01/1998 12405.40 1.011802 1.17 02/01/2000 13027.50 1.072010 6.95 24/11/1996 9455.31 1.070973 6.86 11/01/1998 12227.30 0.985643 -1.45 09/01/2000 13607.10 1.044491 4.35 01/12/1996 9965.70 1.053979 5.26 18/01/1998 12066.30 0.986833 -1.33 16/01/2000 13839.30 1.017065 1.69 08/12/1996 10160.80 1.019577 1.94 25/01/1998 11875.60 0.984196 -1.59 23/01/2000 14577.30 1.053326 5.20 15/12/1996 10396.50 1.023197 2.29 01/02/1998 11619.70 0.978452 -2.18 30/01/2000 13995.30 0.960075 -4.07 22/12/1996 10246.30 0.985553 -1.46 08/02/1998 11521.00 0.991506 -0.85 06/02/2000 13788.50 0.985224 -1.49 29/12/1996 10251.10 1.000468 0.05 15/02/1998 11485.70 0.996936 -0.31 13/02/2000 14082.60 1.021329 2.11 05/01/1997 11311.30 1.103423 9.84 22/02/1998 11541.10 1.004823 0.48 20/02/2000 13691.10 0.972200 -2.82 12/01/1997 11841.90 1.046909 4.58 01/03/1998 11522.70 0.998406 -0.16 27/02/2000 12495.90 0.912702 -9.13 19/01/1997 11784.30 0.995136 -0.49 08/03/1998 11719.50 1.017079 1.69 05/03/2000 12630.10 1.010740 1.07 26/01/1997 12588.80 1.068269 6.60 15/03/1998 11772.60 1.004531 0.45 12/03/2000 12786.10 1.012351 1.23 02/02/1997 13574.60 1.078308 7.54 22/03/1998 11885.70 1.009607 0.96 19/03/2000 12625.90 0.987471 -1.26 09/02/1997 14848.00 1.093808 8.97 29/03/1998 12002.60 1.009835 0.98 26/03/2000 12336.20 0.977055 -2.32 16/02/1997 15310.50 1.031149 3.07 05/04/1998 11976.00 0.997784 -0.22 02/04/2000 12514.00 1.014413 1.43 23/02/1997 16135.00 1.053852 5.25 12/04/1998 11989.00 1.001086 0.11 09/04/2000 12393.00 0.990331 -0.97 02/03/1997 15561.00 0.964425 -3.62 19/04/1998 11954.90 0.997156 -0.28 16/04/2000 11987.30 0.967264 -3.33 09/03/1997 15580.50 1.001253 0.13 26/04/1998 11824.20 0.989067 -1.10 23/04/2000 10832.40 0.903656 -10.13 16/03/1997 15523.80 0.996361 -0.36 03/05/1998 11769.60 0.995382 -0.46 30/04/2000 11196.30 1.033594 3.30 23/03/1997 14685.20 0.945980 -5.55 10/05/1998 11595.90 0.985242 -1.49 07/05/2000 11058.50 0.987692 -1.24 30/03/1997 14650.20 0.997617 -0.24 17/05/1998 11295.60 0.974103 -2.62 14/05/2000 11391.20 1.030085 2.96 06/04/1997 14798.70 1.010136 1.01 24/05/1998 11123.40 0.984755 -1.54 21/05/2000 11701.40 1.027232 2.69 13/04/1997 14865.90 1.004541 0.45 31/05/1998 10734.30 0.965020 -3.56 28/05/2000 10798.10 0.922804 -8.03 20/04/1997 14767.40 0.993374 -0.66 07/06/1998 10454.80 0.973962 -2.64 04/06/2000 10847.60 1.004584 0.46

27/04/1997 15060.70 1.019861 1.97 14/06/1998 10664.80 1.020086 1.99 11/06/2000 10151.20 0.935801 -6.64 04/05/1997 14645.90 0.972458 -2.79 21/06/1998 10321.70 0.967829 -3.27 18/06/2000 10014.80 0.986563 -1.35 11/05/1997 14369.00 0.981094 -1.91 28/06/1998 10300.30 0.997927 -0.21 25/06/2000 9164.37 0.915083 -8.87 18/05/1997 13751.90 0.957053 -4.39 05/07/1998 10020.40 0.972826 -2.76 02/07/2000 8999.17 0.981974 -1.82 25/05/1997 13888.60 1.009940 0.99 12/07/1998 9821.99 0.980199 -2.00 09/07/2000 9391.09 1.043551 4.26 01/06/1997 13228.60 0.952479 -4.87 19/07/1998 9709.95 0.988593 -1.15 16/07/2000 9259.56 0.985994 -1.41 08/06/1997 13636.70 1.030850 3.04 26/07/1998 9952.34 1.024963 2.47 23/07/2000 8651.17 0.934296 -6.80 15/06/1997 13471.30 0.987871 -1.22 02/08/1998 10102.20 1.015058 1.49 30/07/2000 8177.32 0.945227 -5.63 22/06/1997 13340.00 0.990253 -0.98 09/08/1998 9862.74 0.976296 -2.40 06/08/2000 7890.54 0.964930 -3.57 29/06/1997 13118.40 0.983388 -1.68 16/08/1998 9664.70 0.979920 -2.03 13/08/2000 7568.87 0.959233 -4.16 06/07/1997 13233.90 1.008804 0.88 23/08/1998 9343.16 0.966730 -3.38 20/08/2000 8341.10 1.102027 9.72 13/07/1997 13099.10 0.989814 -1.02 30/08/1998 9011.08 0.964457 -3.62 27/08/2000 8326.98 0.998307 -0.17 20/07/1997 12900.00 0.984800 -1.53 06/09/1998 9490.19 1.053169 5.18 03/09/2000 8167.98 0.980905 -1.93 27/07/1997 12602.50 0.976938 -2.33 13/09/1998 9503.97 1.001452 0.15 10/09/2000 8456.60 1.035336 3.47 03/08/1997 12622.30 1.001571 0.16 20/09/1998 9533.42 1.003099 0.31 17/09/2000 8116.16 0.959743 -4.11 10/08/1997 12564.70 0.995437 -0.46 27/09/1998 9566.63 1.003484 0.35 24/09/2000 7778.43 0.958388 -4.25 17/08/1997 12580.60 1.001265 0.13 04/10/1998 9589.12 1.002351 0.23 01/10/2000 7476.66 0.961204 -3.96 24/08/1997 13036.80 1.036262 3.56 11/10/1998 9432.51 0.983668 -1.65 08/10/2000 6987.80 0.934615 -6.76 31/08/1997 13532.30 1.038008 3.73 18/10/1998 9439.63 1.000755 0.08 15/10/2000 6076.31 0.869560 -13.98 07/09/1997 13667.30 1.009976 0.99 25/10/1998 9346.40 0.990124 -0.99 22/10/2000 6888.93 1.133736 12.55 14/09/1997 13964.60 1.021753 2.15 01/11/1998 9184.68 0.982697 -1.75 29/10/2000 7304.37 1.060305 5.86 21/09/1997 14048.70 1.006022 0.60 08/11/1998 9132.23 0.994289 -0.57 05/11/2000 7473.64 1.023174 2.29 28/09/1997 13994.50 0.996142 -0.39 15/11/1998 9178.22 1.005036 0.50 12/11/2000 7734.45 1.034897 3.43 05/10/1997 13983.30 0.999200 -0.08 22/11/1998 9171.60 0.999279 -0.07 19/11/2000 8727.00 1.128328 12.07 12/10/1997 13870.30 0.991919 -0.81 29/11/1998 9068.02 0.988706 -1.14 26/11/2000 7992.45 0.915830 -8.79 19/10/1997 13621.90 0.982091 -1.81 06/12/1998 9026.21 0.995389 -0.46 03/12/2000 7969.77 0.997162 -0.28 26/10/1997 13649.20 1.002004 0.20 13/12/1998 8890.94 0.985014 -1.51 10/12/2000 7902.33 0.991538 -0.85 02/11/1997 13482.40 0.987780 -1.23 20/12/1998 9025.75 1.015163 1.50 17/12/2000 7873.65 0.996371 -0.36 09/11/1997 13334.60 0.989038 -1.10 27/12/1998 9068.91 1.004782 0.48 24/12/2000 7566.23 0.960956 -3.98 16/11/1997 12993.70 0.974435 -2.59 03/01/1999 9141.83 1.008041 0.80 31/12/2000 7537.95 0.996262 -0.37

23/11/1997 12539.30 0.965029 -3.56 10/01/1999 9838.73 1.076232 7.35 07/01/2001 7578.22 1.005342 0.53 30/11/1997 12601.60 1.004968 0.50 17/01/1999 9899.59 1.006186 0.62 14/01/2001 7524.17 0.992868 -0.72 07/12/1997 12026.60 0.954371 -4.67 24/01/1999 10161.40 1.026447 2.61 21/01/2001 7227.11 0.960519 -4.03 14/12/1997 12184.80 1.013154 1.31 31/01/1999 11057.90 1.088226 8.45 28/01/2001 7558.68 1.045879 4.49 21/12/1997 12147.30 0.996922 -0.31 07/02/1999 10945.90 0.989871 -1.02 04/02/2001 7694.49 1.017967 1.78 28/12/1997 12260.70 1.009335 0.93 14/02/1999 10536.20 0.962570 -3.81 11/02/2001 7476.80 0.971708 -2.87

21/02/1999 10717.70 1.017226 1.71 18/02/2001 7164.66 0.958252 -4.26 28/02/1999 10551.00 0.984446 -1.57 25/02/2001 6962.00 0.971714 -2.87 07/03/1999 10398.60 0.985556 -1.45 04/03/2001 6724.88 0.965941 -3.47 14/03/1999 10412.00 1.001289 0.13 11/03/2001 6879.29 1.022961 2.27 21/03/1999 10276.50 0.986986 -1.31 18/03/2001 6349.36 0.922967 -8.02 28/03/1999 10313.60 1.003610 0.36 25/03/2001 6161.27 0.970377 -3.01 04/04/1999 10349.30 1.003461 0.35 01/04/2001 5916.55 0.960281 -4.05 11/04/1999 10249.40 0.990347 -0.97 08/04/2001 6017.71 1.017098 1.70 18/04/1999 10264.50 1.001473 0.15 15/04/2001 6293.02 1.045750 4.47 25/04/1999 10382.40 1.011486 1.14 22/04/2001 6104.23 0.970000 -3.05 02/05/1999 10144.30 0.977067 -2.32 29/04/2001 6177.83 1.012057 1.20 09/05/1999 10272.40 1.012628 1.25 06/05/2001 6341.10 1.026428 2.61 16/05/1999 10154.00 0.988474 -1.16 13/05/2001 6489.01 1.023326 2.31 23/05/1999 10120.50 0.996701 -0.33 20/05/2001 6597.23 1.016677 1.65 30/05/1999 9865.98 0.974851 -2.55 27/05/2001 6654.19 1.008634 0.86 06/06/1999 9770.53 0.990325 -0.97 03/06/2001 6537.40 0.982449 -1.77 13/06/1999 10073.70 1.031029 3.06 10/06/2001 6292.23 0.962497 -3.82 20/06/1999 9891.66 0.981929 -1.82 17/06/2001 6300.35 1.001290 0.13 27/06/1999 10261.50 1.037389 3.67 24/06/2001 6139.67 0.974497 -2.58 04/07/1999 9952.82 0.969919 -3.05 01/07/2001 5969.53 0.972288 -2.81 11/07/1999 9956.00 1.000320 0.03 08/07/2001 6203.32 1.039164 3.84 18/07/1999 10121.70 1.016643 1.65 15/07/2001 6095.65 0.982643 -1.75 25/07/1999 9819.62 0.970155 -3.03 22/07/2001 5547.10 0.910010 -9.43 01/08/1999 9719.97 0.989852 -1.02 29/07/2001 5509.17 0.993162 -0.69

08/08/1999 9532.29 0.980691 -1.95 05/08/2001 5285.55 0.959409 -4.14 15/08/1999 9350.49 0.980928 -1.93 12/08/2001 5535.72 1.047331 4.62 22/08/1999 9441.02 1.009682 0.96 19/08/2001 5619.18 1.015077 1.50 29/08/1999 9353.39 0.990718 -0.93 26/08/2001 5647.62 1.005061 0.50 05/09/1999 9286.50 0.992849 -0.72 02/09/2001 5957.84 1.054929 5.35 12/09/1999 9238.43 0.994824 -0.52 09/09/2001 6427.37 1.078809 7.59 19/09/1999 9365.83 1.013790 1.37 16/09/2001 6263.37 0.974484 -2.58 26/09/1999 9633.55 1.028585 2.82 23/09/2001 6148.17 0.981607 -1.86 03/10/1999 9644.66 1.001153 0.12 30/09/2001 5619.25 0.913971 -9.00 10/10/1999 10084.30 1.045584 4.46 07/10/2001 5446.80 0.969311 -3.12 17/10/1999 10673.40 1.058418 5.68 14/10/2001 5545.29 1.018082 1.79 24/10/1999 10192.30 0.954925 -4.61 21/10/2001 5797.97 1.045567 4.46 31/10/1999 10382.80 1.018691 1.85 28/10/2001 5713.35 0.985405 -1.47 07/11/1999 10475.50 1.008928 0.89 04/11/2001 5548.61 0.971166 -2.93 14/11/1999 10715.10 1.022872 2.26 11/11/2001 5581.92 1.006003 0.60 21/11/1999 10771.40 1.005254 0.52 18/11/2001 5333.98 0.955582 -4.54 28/11/1999 11042.20 1.025141 2.48 25/11/2001 5085.62 0.953438 -4.77 05/12/1999 11522.50 1.043497 4.26 02/12/2001 5196.33 1.021769 2.15 12/12/1999 13386.90 1.161805 15.00 09/12/2001 5164.32 0.993840 -0.62 19/12/1999 12357.80 0.923126 -8.00 16/12/2001 5342.09 1.034423 3.38 26/12/1999 12152.40 0.983379 -1.68 23/12/2001 5311.80 0.994330 -0.57 30/12/2001 5262.41 0.990702 -0.93 Std. Dev. 3.26 2.80 4.56 Skewness 0.80 1.81 0.11 Kurtosis 0.84 8.29 0.79 1. Index values for the period prior to November 1996 were unobtainable during the research conducted. However, including Those values would have made the validity of the statistical measures for the period questionable as many of the highly-liquid/ highly-traded stocks were listed during late 1996 and started active trading during 1997.

The table shows that Standard Deviation has decreased from 3.26% for the period

1996/1997 to 2.8% for the period 1998/1999 indicating a mild volatility during the

second period.

Skewness and kurtosis coefficients have increased during the period 1998/1999

indicating an increased shift in returns from normal distribution.

Based on the above, the calculation of Beta for the stocks analysed has been confined

to the period 1998/1999 and the values obtained were used to measure abnormal

returns for securities around announcements related to acquisitions and dividend

distributions during 2000 and 2001.

Finally, in the calculation, continuous compounding of both index and securities

returns was assumed. This can be shown by the following mathematical formulae:

rI = ln (Vt / Vt-1) (4.3)

ri = ln (Pt / Pt-1) (4.4)

Where, rI is the index return, Vt is index value at date t, Vt-1 is index value at date t-1,

ri is the return on security i, Pt is security price at date t, Pt-1 is security price at date

t-1 and ln is the natural logarithm of value calculated

Appendix B shows the detailed Beta calculations for the 12 securities analysed, which

are a subset of the most actively traded stocks and for which dividend and/or

acquisition data were available for the period analysed. (Note that the most actively

traded 30 securities accounted for 82.26% of market liquidity as of June 2001 which

makes the number of securities analysed a fair representation of the market under the

information constraint).

4.2. Data

For the 12 securities involved, Beta calculations were based on 104 weekly

observations of index values and securities prices starting from 2nd of January 1998

until 24th December 1999.

Calculations of Abnormal Returns around dividends and acquisitions announcements

were based on 42 daily observations of index values and securities prices surrounding

the Announcement date for each case.

Index values were obtained from REUTERS while stock prices were obtained from

various sources including REUTERS, DATASTREAM and the Cairo and Alexandria

Stock Exchanges website.

The 12 securities analysed are all Large Capitalisation-Value stocks to avoid

anomalies associated with Small Capitalisation-Growth stocks, which are

characterised by the lack of accurate information and analysis and by infrequent

trading within the Egyptian market.

Table 4.2 below provides summary statistics of the 12 securities analysed. These

securities represent the major sectors of the market and were used as proxies for the

overall market performance.

Table 4.2. Summary Statistics of Stocks Analysed

Company Beta Alpha Std. Dev. Of Rdm Std. Error of Std. Error of Correlation Coefficient of Coefficient of % Error Term % Beta Alpha Coefficient Determination Nondetermination Banking

Commercial International Bank (CIB) 1.45 -0.06 3.12 0.062 0.174 0.80 0.63 0.37 Egyptian American Bank (EAB) 1.18 -0.40 3.38 0.065 0.181 0.70 0.49 0.51 Misr International Bank (MIBANK) 1.27 -0.36 3.14 0.062 0.174 0.75 0.57 0.43 Cement Ameryah Cement 1.05 -0.43 3.58 0.067 0.187 0.64 0.41 0.59 Helwan Portland Cement 0.85 -0.56 3.26 0.064 0.178 0.60 0.35 0.65 Suez Cement 1.26 -0.20 2.71 0.058 0.162 0.80 0.63 0.37 Torah Portland Cement 1.07 -0.06 3.77 0.068 0.191 0.63 0.39 0.61 Food and Beverages Upper Egypt Flour Mills 0.87 -0.75 4.91 0.078 0.218 0.45 0.20 0.80 Housing Nasr City for Housing and Development 0.75 -1.15 4.44 0.074 0.208 0.43 0.18 0.82 Chemicals Abu Keir for Fertilisers 0.47 -0.94 3.89 0.070 0.194 0.33 0.11 0.89 Egyptian Financial and Industrial 0.86 -1.26 2.86 0.060 0.167 0.65 0.42 0.58 Paints and Chemical Industries 0.78 -0.71 4.10 0.071 0.200 0.47 0.22 0.78

The only exception with securities selection was for companies within the

Telecommunication and Media sector, where none of the constituent companies was

included as most of the companies in the sector are relatively newly listed with hardly

any dividend or acquisition data available for the period analysed.

4.3. Findings

Appendix C provides the detailed calculations of Abnormal Returns for the securities

analysed around the announcement dates of the various events tested.

4.3.1. Takeovers

Efficiency tests related to Acquisition events included the acquisition announcements

for two companies in the cement sector during 2001, namely the acquisition of

94.69% of Helwan Portland Cement shares by the Arab Swiss Engineering Company

(ASEC) and 34.65% of Suez Cement shares by Ciments Francais. (Cairo and

Alexandria Stock Exchanges Monthly Bulletin, May 2002)

Tables (4.3) and (4.4) and Graphs (4.1) and (4.2) show the following:

Despite fluctuating around 0.40% per day, which might be considered relatively

insignificant, Average Abnormal Returns have shown positive values for the entire

period of the test.

This persistent positive trend has caused Average Cumulative Abnormal Returns to

increase at a steady rate during the period.

A possible explanation for this behaviour is that there might have been an information

leakage about the intended acquisitions well before the announcement date. This has

caused abnormal returns to be positive days before the announcement date.

Table 4.3. Average Abnormal Returns: Takeovers, Table 4.4. Cumulative Abnormal Returns: Takeovers, 2001 2001

Day Helwan Portland Suez Cement AAR (%)

-18 0.55 0.18 0.36 -17 0.56 0.19 0.38 -16 0.57 0.22 0.39 -15 0.59 0.23 0.41 -14 0.59 0.18 0.38 -13 0.59 0.17 0.38 -12 0.55 0.16 0.36 -11 0.61 0.17 0.39 -10 0.59 0.20 0.40 -9 0.55 0.22 0.38 -8 0.53 0.22 0.37 -7 0.57 0.19 0.38 -6 0.57 0.19 0.38 -5 0.56 0.19 0.38 -4 0.56 0.23 0.39 -3 0.59 0.22 0.41 -2 0.61 0.20 0.41 -1 0.59 0.17 0.38 0 0.54 0.20 0.37 1 0.60 0.20 0.40 2 0.60 0.19 0.40 3 0.59 0.18 0.38 4 0.62 0.24 0.43 5 0.63 0.25 0.44 6 0.50 0.20 0.35 7 0.51 0.14 0.33 8 0.60 0.19 0.39 9 0.61 0.18 0.39

10 0.68 0.16 0.42 11 0.58 0.16 0.37 12 0.58 0.26 0.42 13 0.54 0.20 0.37 14 0.57 0.19 0.38 15 0.59 0.20 0.40 16 0.57 0.21 0.39 17 0.57 0.15 0.36 18 0.58 0.19 0.39 19 0.58 0.22 0.40 20 0.51 0.19 0.35 21 0.56 0.19 0.38

DayHelwan Portland Suez Cement Avg. CAR

-18 1.12 0.38 0.75 -17 1.67 0.57 1.12 -16 2.25 0.79 1.52 -15 2.84 1.02 1.93 -14 3.43 1.2

The Performance of the Egyptian Stock Market_Bassam Azab

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