EMERGING STOCK MARKETS

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EMERGING STOCK MARKETS
AND
GROWTH OF DEVELOPING ECONOMIES:
THE NIGERIA CASE
1980-2004
BY
AYOOLA ALEXANDER, AKINWUMI
(MAC/2001/107)
BEING A THESIS SUBMITTED TO THE DEPARTMENT OF MANAGEMENT AND
ACCOUNTING, FACULTY OF ADMINISTRATION, OBAFEMI AWOLOWO
UNIVERSITY, OSUN STATE, NIGERIA.
IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR THE AWARD OF
BACHELOR OF SCIENCE (B.Sc.) IN
ACCOUNTING
OCTOBER, 2006

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~TABLE OF CONTENT~
INTRODUCTION
1.1 Background of the Study 1
1.2 Statement of Problem 4
1.3 Research Questions 5
1.4 Objectives of the Study 5
1.5 Scope of the Study 6
1.6 Research Hypotheses 7
1.7 Limitation of the Study 7
1.8 Justification of the Study 8
1.9 Nigeria Economy and the Stock Exchange – The Background 9
1.10 Operational Definition of Terms 14
LITERATURE REVIEW
2.1 The Nexus of financial intermediaries and Economic growth 19
2.2 A synopsis of global equity market– Kai Li’s Perspective. 27
2.3 Emerging Stock Market- Operational Analysis 30
2.4 Emerging Equity Markets – Embryos or Casinos? 32
2.5 Evolution of Emerging Markets – The Faber’s Theory. 35
2.6 Emerging Stock Markets and Economic Growth –
Characteristics & the Channels of Contribution. 37
2.6.1 Legal, Regulatory, and Institutional Framework38
2.6.2 Liberalization 40
2.6.3 Liquidity 45
2.6.4 Volatility 47
2.7 Evidences of Economic Growth 50
2.8 The Nigerian Stock Exchange and Nigeria Economy 53
RESEARCH METHODOLOGY
3.1 Area of Study 57
3.2 Source of Data 57

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3.3 Sampling Technique and Sample Size. 58
3.4 Measurement of Variables 59
3.4.1 Variable in the Study 59
3.4.2 Scale of Measurement 60
3.5 Research Instrument 61
3.5.1Validation of Research Instrument & Testing 62
3.6 Data Analysis Technique 62
PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
4.1 Response Rate 66
4.2 Respondents’ Profile 66
4.3 Presentation and Analysis of Data According to Research Objectives. 70
4.3.1 Relationship between Stock Market Development and Economic Growth70
4.3.2 Perception of the Nigeria Stock Exchange 76
4.3.3 Development of the Nigeria Stock Exchange 82
4.3.4 The Nigeria Stock Market’s Role in the
Actualization of Current Economic Reconstruction 84
4.4 Test of Hypotheses 87
4.4.1 First Hypothesis 87
4.4.2 Second Hypothesis 89
4.4.3 Third Hypothesis 92
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary 98
5.2 Conclusions 100
5.3 Recommendations 101

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~LIST OF TABLES~
2.1 Recent Empirical Studies on Finance-Growth Relationship 22-24
4.1 Professional Qualifications 66
4.2 Job Specification 68
4.3 Number of Investor 69
4.4 Experience with Stock Market 69
4.5 Nigerian Stock Market Contributions towards Economic Growth 70
4.6 Response Rate in Percentage 71
4.7 Stock Market Development and Economic Growth Indicators 73
4.8 Operation Description of Stock Market 76
4.9 Developmental Variables of Stock Market 82
4.10 Weighted Score of the Market Significance in Privatization Process 85
4.11 Weighted Score of the market Significance in NEEDS Actualization 86
4.12 Observed Frequencies 87
4.13 Calculating Expected Frequencies 88
4.14 Contingency Table 88
4.15 Chi-square test Calculation 89
4.16 Computation of Intermediate Values Needed
For Calculating Correlation Coefficient Appendix
4.17 Computation of Intermediate Values Needed
For Calculating Correlation Coefficient (2) Appendix

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~LIST OF FIGURES~
1.1 Oil, non-oil and total GDP Growth, Nigeria 1981-2000 10
2.1 World Equity Market Capitalization and Emerging Market Share. 28
2.2 Changes in Stock Market Liquidity and Volatility following Liberalization 43
2.3 Economic Growth of Countries between 1976&1993 by Market Liquidity in 1976 46
2.4 Emerging Stock Markets Volatility (IFCI Annualized Standard Deviation) 50
4.1 Professional Qualification 67
4.2 Composition of Respondents' Professional Qualification 67
4.3 Job Composition of Respondents 68
4.4 Experience with Stock Market 68
4.5 Stock Market Influence on Economic Growth 71
4.6 Nigerian Stock Market Growth (Capitalization&Equity) 74
4.7 Nigerian Stock Market Growth (Capitalization&Total Market) 74
4.8 Scatter Diagram of the Relationship between SMCR/GDP 75
4.9 Scatter Diagram of the Relationship between STR*/GDP 76
4.10 Operation Perception of Nigerian Stock Market 77
4.11 Assessment of Investment Opportunities and Decision 78
4.12 Acceptance of Economic and Company Influences on the Stock Market 79
4.13 Predictability of Gains and Losses on the Nigerian Stock Market 80
4.14 Proportion of Responses 80
4.15 Growth Pattern of Nigerian Stock Market 81
4.16 Weighted Score of Nigerian Stock Exchange Developmental Variables 83
4.17 The Nigerian Stock Market Role in Privatization Process .84
4.17 Nigeria Stock Exchange role in NEEDS actualization 85
4.18 Nigerian Stock Market Contributions towards Economic Recovery 86

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~LIST OF PLATE~
3.1 Nigerian Stock Exchange Trading Floor 57

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~ABSTRACT~
Providing an acceptable analysis of real economic growth process and prospects in developing countries as a
consequence of stock market development is a cumbersome challenge for modern financial theorists. With a detailed
examination of the interplay between stock market development and economic growth in a number of developing nations this
study attempts empirical assessment of the Nigerian case. In pursuing the problem of whether a significant relationship exist
between stock market development and economic growth, the study unravels what are the contributions of emerging stock
markets to the developing economies particularly Nigeria.
However, this study employs already established parameters of stock market-growth nexus (liquidity, liberalization,
returns, legal etc) to account for stock market influence on Nigeria economy on three frontiers; namely contributions,
correlation and causality. With data from secondary sources like FOS, CBN and SEC backing primary data collected
among Nigerian brokers and financial mangers the study was able to come up with enough evidences on the 3 frontiers.
Apparently, evidences of stock market contributions were observed while with the use of Pearson sample correlation
coefficient proves a fair relationship between the two variables of interest exists. However, in filling the lacuna of causality by
using Granger-causality tests, the study finds no evidence of causality. Juxtaposition of the current features of the stock market
with its intangible past trends places the market indeed in the categories of the emerging markets. The Nigeria stock market
could be said to be in its chrysalis-phase of its emergence cycle beaming with high prospects of being a high gear in the economic
development process.

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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
In contemporary Economics, economic power is synonymous to political dominance and the
volume of such economic power dictate the influence of the holding country in the commonwealth of
nations. In the light of the foregoing, Economic growth and development has always been the focal point
of any rational government and the acceleration and alacrity of such development the pursuit of highly
dynamic and ambitious administrations.
Over the last four centuries, the world economy has gradually graduated from a paltry subsistence
agrarian economy through an inevitable revolutionary industrial economy towards a highly evolutionary
technological (or Information) economy. But the demands of production cycles processes that have
calibrated these various stages of development have help refashioned the financial institutions again and
again in responding to such demands.
The demand of the agrarian economy was solely provided for by personal capital and sometimes
by borrowings from kith and kins but the industrial economy witnessed a need of large financing for
mechanized production process that was being employed to beat the menace prophesied by T.R. Malthus
(an eighteenth century UK economist). Gargantuan financing desired to fuel the American industrialist;
Henry Ford-pioneered concept of mass production went on to transform the world of finance too. As
observed by Joseph Schumpeter (1912) technological innovation is the fore underlying long-run economic
growth, and that the cause of innovation is the financial sector’s ability to extend credit to the
entrepreneur.
Because of the inability of the existing banking system to cater for the entirety of funds required
by the industries of Iron-Steam-Steel-Electricity era equity markets started burgeoning as early as

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seventeenth century. Countries like France, Britain, Belgium, German, Australia and United States that
witnessed the initial and subsequent proliferation of the industrial revolution conceived the first world
capital markets. At first these markets were loosely organized but were later legalized and liberalized in the
late eighteenth century when the sovereign governments in such countries acknowledge their
contributions towards technological advancement and economic development.
Hicks (1969) argues that in the nineteenth century, for the first time in history, many private
investment projects were so large that they could no longer be financed by individuals or from retained
profits. The technological inventions of the industrial revolution, such as steam engine, have been made
before, but their implementation had to wait for well developed financial markets. The industrial society
required an adapted financial system where publicly traded companies could get long-term financing.
The developing economies of the pre-world war I era (whether capitalist or planned) quickly
juxtaposed their money market (mainly banking) and capital market (chiefly stock market) in productive
alignment towards fostering economic development. Through the agonies of world wars and the Great
Depression of the 1930s, these countries still emerged economic super powers.
The capital market has been heralded as potent factor amidst the various non-banking financial
institutions as the pivot of accelerated development in modern economic history. Financial markets allow
for more efficient financing of private and public investment projects. By representing ownership of large-
value, indivisible physical assets by easily tradeable and divisible financial assets and making trade in them
more liquid, they promote the efficient allocation of capital. Apparently an effective stock market fulfils
this role which subsequently contributes towards economic growth as capital accumulation is furthered
and technological advancements are annexed because the needed funds are being made available.
This view will be well appreciated from the last two decade’s perspective of industrialized nations
as the capital markets have helped in quick equity generation thereby leading to accelerated increase in
capital investment to match the new opportunities presented by computer innovation and introduction

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into production processes. For example the Japanese economy within thirty years after closing her borders
emerges one of the world leading industrial economy and the world’s largest creditor. Japan today boasts
of one of the world most capitalized stock market.
Nevertheless, financial institutions have always served as the machinery of the governments in
gearing their respective economies towards higher development and as a tool in annexing economic gains
from colonial territories, neighbouring economies or allies. Laws, decrees and statutes enacted by the
government are employed in protecting, promoting and regulating the activities of the various financial
institutions in bringing about the needed change in the economic variables of Gross Domestic Product
(GDP), Consumer Price Index (CPI), Exchange Rate, Interest Rate etc; which are the means of measuring
the viability of economic development.
It is no wonder that stock markets have become the newly coveted brides of investment-grooms,
policy makers and economy-planners because the global equity markets have experienced their most
explosive growth over the past thirty years and emerging equity markets have experienced an even more
rapid growth, taking on an increasingly larger share of this global boom (i.e. global capitalization). Recent
world financial statistics provides that industrialized world capital markets are saturated; not in
opportunities but in rate of returns and number of potential investors. Of course, nothing gives a higher
return than a newly cultivated virgin land and in the recent past the developing world has become the
focus of industrialized government, their financial houses and venture capitalists. They have embraced
every means of entering into the financial arena of the developing economies mainly in the name of Aids,
Foreign Direct Investments (FDIs), overseas loans, grants etc.
Cognizance must as well be taken that the relationship in last few years has been marriage like as
ambitious developing world government and big corporations in such economies; in pursuit of greater
capital at lower cost have taken their capital market dealings into international exchanges in the guise of
Global Depository Receipt (GDR) and America Depository Receipt (ADR), and risk diversification. This

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view has led to the developing world being tagged as emerging market and it has become object of
immense interest. But the big question is, “what is this new bride, stock market contributing to their
respective economies and most especially these developing economies where the main focus lies?”
The Nigerian stock market is not an expectation in fact, in the past five years it has become the
object of international appeal and the Exchange is reputed to be operating at the same level as the Stock
Exchanges of the mature markets while being classified as an emerging market. With the
acknowledgement that The International Finance Corporation (IFC) has consistently rated The Nigerian
Stock Market highly on dividend yield and in 2000 as the Number 1 Emerging Stock Market in the world
suggests a verification of the contributions of the exchange towards Nigeria economic growth.
Nevertheless, some financial analysts still maintain that the stock market is a casino of a sort most
especially stock exchanges of the emerging economies; where trade liberalization is restricted, market
volatility is high and economic stability is fragile.
1.2 Statement of Problem
While some economists and financial analysts esteem the stock markets as parallel to the bank in
its contributions towards economic development along with some added advantages still some critics view
stock markets in developing economies as organized casinos (Irving 2000), arguing that such markets
could expose already fragile developing economies to the destabilizing effects of short term, speculative
capital flow. Critically, casino has been the term being used by first world financial managers to describe
the budding developing world market dues to their volatility.
On the other hand, it is statistically backed that stock markets in developing countries account for
a disproportionately large share of the boom in global stock market activity (Levine 1997), in view of this
developing countries policy makers and economists are exercising the phobia of another economic
imperialism from previous colonial master and world super powers considering that the growth of their

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stock exchanges have been partly fuelled by FDI from such colonial allies and developed nations. Are all
the gains that accrue from these markets eroded abroad? Aren’t the local economies gaining from this
boom?
In the light of the fear of the weight of the dilemma aforementioned it is inquisitorial enough to
ask and study the questions is there indeed, in a developing economy, a significant relationship between stock market
development and economic growth? And, what are the contributions of emerging stock markets to these developing economies?
1.3 Research Questions
In giving significant answer to the imminent questions aforesaid this study will diligently pursue its
objectives with the following apparent queries in consideration:
Is there a direct relationship between stock market development and economic growth?
Are emerging stock markets casinos or embryos?
Is The Nigerian Stock Market pivotal to the current economic construction in Nigeria?
1.4 Objectives of the Study
It is aim of this study in relation to the Nigerian scenario to
a) examine the relationship between Stock Market development and Economic Growth.
b) assess whether Developing world stock markets are casinos.
c) determine whether The Nigerian Stock Exchange is an emerging market.
d) assess the role of The Nigerian Stock Market in the actualization of the current economic
reconstruction.

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1.5 Scope of the Study
The context of the preference of this study focuses on the influences of Stock markets in the
developing world’s economy, particularly the Nigerian case. It assesses the development (degree of
maturity) of the stock market and its macroeconomic roles. The Nigerian Stock Exchange has been over
forty-two years in operation; a dynamic reflection of developmental contributions towards Nigeria
economic growth would have encompasses a detail analysis of her existence, development and effect on
the economy. This study only employs a twenty-five year period (an era from 1980 to 2004) in its
empirical study.
The concept of this research emanated from controversy over the real contributions of financial
intermediaries to economic growth and whether they cause development. Much contested is the pursuit of
an answer to this question in the developing world where their stock market is believed to be at best
glorified exchanges. Recently, it is being upheld that instead of begging this question from a global
perspective country specific answers hold be sort.
Stemming from the above-mentioned the physical boundary of interest to this study is the Nigerian Stock
Market. A market with tentacles all over the main regions of the country and with at least mild influence
on the Nigeria corporate sphere, The Nigerian Stock Market invariably afford a nonnegotiable bases for
the answering of this pertinent question.
However, this study analyzes the character of stock market (capitalization and trading) as
efficacious apparatus in contribution towards accelerated economic growth. Other parameters like stock
market turnover ratio and returns (yields); important to measuring the market growth or maturity; are not
employed in empirical analysis. This is due to unavailability of congruence data on such variables. Other
factors like education (literacy rate), exports, imports, government policies, foreign direct investment and
the likes that influence either of the variables in questions are not under the searchlight of this study. Also,

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qualitative factors such as shareholders’ sentiment, corporate news and rumours and legal barriers, which
influence stock market growth and invariably affect the economy, are not put into consideration
1.6 Research Hypotheses
In regards to the interest of the study and appraising the Nigerian case in the light of the
argument, this study will be investigating at three different levels the relationship between the stock
market and the economy:
First hypothesis: H0: The Nigerian Stock Market does not make significant contributions towards
Economic Growth.
Second hypothesis: H0 : The Development of Nigerian Stock Market has no correlation with
Economic Growth.
Third hypothesis: H0: The development of the stock exchange does not cause growth in
the economy.
1.7 Limitation of the Study
From literature it is apparent that there exists another school of thought that holds that economic
growth initiate first and then simulates the development of financial intermediaries (stock market
inclusive). This link of causality pioneered by Joan Robinson (1952) who postulated that economic growth
creates a demand for various types of financial services to which the financial system responds, has lately
been popularized by empirical studies. In accommodating this fact, majority of recent studies have
suggested bi-directionality in this growth-finance nexus. However, this study focuses only on the link that
stems from financial intermediary development towards economic growth. Moreover, it is further
narrowed down to the perspective of capital market as a financial intermediary and further to stock
market; a sub-set of that capital market.

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At whatever level research is always with a degree of deviation from being a perfect study.
Unquestionably, this study suffers its own inevitable limitations. In the analysis of required data the tools
used are of moderate confidence in the context of what is obtained in similar research in the field as much
more advanced statistical tools are used in handling analysis technique.
Another obstacle is of that which most Nigerian studies suffer and it is of variances in the content
of available data obtainable from supposed relevant authorities. It is not uncommon to find two or three
different set of figures for same economic variable though most time such varying set falling within same
range but not precise. Therefore, conscious and reliable effort has to be made in agreeing the set of
secondary data.
Barring the constraint of fund, time and capacity, an important quest like this would have
employed wider and varying samples in the treatment of primary analysis. Such will be pooling
respondents from the entirety of the Nigeria capital markets; participants in all aspects of the markets
sphere.
In evaluating the whole context of this research study it would be of immense value to explore the
entire boundaries presented by this query. This is because it’s a kind of study that demands both a
microscopic and telescopic perspective to the consideration of such fundamentals. Nevertheless, enough
finite scopes are touched to offer an acceptable platform for the study.
1.8 Justification of the Study
The influences and role of financial entities apart from banking has often being down played partly
because of unawareness on the part of our financial illiterate population and partly due to their
underdevelopment in time past. However, with greater demand for capital either for expansion or new
project from private participation in the economy and reduced government control of such financial
intermediaries, relevance of such intermediaries most especially the stock market is required.

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With qualitative contributions of the stock market towards national economic growth obviously
this study will be acceptable by Members of the Nigerian Stock Exchange (NSE), regulators of Nigeria
capital market (e.g. Security Exchange Commission (SEC) and the Central Bank of Nigeria), investment
bankers with interest in fast developing market, venture capitalists, Multinationals operating in Nigeria,
Shareholders, corporate executives of quoted companies and finance scholars.
This study will unravel the indefatigable roles of brokerage companies in economic development,
provide some sort of feedback of the efficacy of operations of the market regulators and assess the quality
of potential investment windows available to shareholders, investment bankers, venture capitalist etc.
1.9 Nigeria Economy and the Stock Exchange – The Background
Nigeria, the most populous black nation, blessed with sizable deposits of world’s choicest
resources, bequeathed with fine natural reserves and the world tenth largest market, is yet to annexed
these economical advantages and (as generally upheld) take her due place in the commonwealth of nations
as a super global power. A country, who gained independence forty-six years ago with heterogeneous
cultures and multilingual tribes, has an average life expectancy ratio, mortality rate and below average
literacy level with a disappointing standard of living as 56 per cent of her citizens are estimated to be living
below the internationally defined poverty line. These are believed to account for the relative unskilled
Nigerian human resources-a weak link in the machinery of development.
Being a mono-product economy largely depended on oil earned money; the country has been
governed mainly by the military who have always managed to usurped power from likewise fraudulent and
non-delivering civil governments. Instability of political rule, mal-administration, mismanagement,
marginalization, corruption, nepotism, a number of civil and intertribal wars, communal unrests and lack
of concise developmental policies and plans which have characterized the length of Nigeria history has
greatly hampered her economic growth.

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In the pre-colonial era, Nigeria was traditionally an agricultural country, providing the bulk of its
own food needs and exporting a variety of agricultural goods, notably palm oil, cacao, rubber, and
groundnuts (peanuts). By the 1970s, however, oil had supplanted cash crops as the major source of
foreign exchange and transformed Nigeria’s economic fortunes. Influenced by rising oil revenues,
Nigeria’s gross domestic product (GDP) rose by an annual average of 6.9 per cent during 1965 to 1980.
During 1980 to 1988, the GDP shrank by 1.1 per cent annually as oil prices and revenues plunged. After
oil prices collapsed during the 1980s the federal and state governments embarked on ambitious
development programmes aimed at diversifying the economy. Only some of these have proved
sustainable and oil revenues remain the principal generator of economic activity in the country. However,
Nigeria’s unpopular military reigns have failed to make significant progress in moving the economy away
from over-dependence on oil, 60 per cent of which is state-owned. The government’s domestic and
international arrears continue to limit economic growth; the largely subsistence agricultural sector has
failed to keep up with rapid population growth, and Nigeria, once a large net exporter of food, now
imports food.
Figure 1.1 Oil, non-Oil, and total GDP growth, Nigeria 1981-2000
Source: Economic Report on Africa 2002: Tracking Performance and Progress page 158

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Obviously, the Nigeria economy since the re-establishment of a new democratic process in May
1999 has witnessed dynamic growth with an improvement in 2000 in the real GDP which rose to 3.8 per
cent against 2.8 and 1.8 per cents in 1999 and 1998 respectively. Rise in government spending following
incessant increase in global oil prices, liberalization of the telecommunication industry and the
privatization process has energized the economic growth process. Even amidst no small opposition, about
#20.2 billion is supposed generated through the Nigerian Stock Exchange in 2002 alone with the
completion of the first two phases of the privatization exercise (Okafor 2002). Nevertheless, Nigerian
economists voiced support for the federal privatization programme, noting that public enterprises had
become channels for political patronage and that they account for more than 55% of national debt and
5% of federal budget deficits. The economists argued that maintaining the momentum in privatization
was critical to modernize technology, strengthen capital markets and attract investors, dismantle
monopolies, promote better enterprise management, eliminate parasitic public enterprises, and reduce
fiscal deficits.
Compared with other countries in the sub-Sahara region, Nigeria has a well-developed and
diversified financial sector. The financial sector of Nigerian economy which has been predominantly
hinged on the banking industry lends an open-door to capital market development with the creation of the
Lagos Stock exchange in June 1961 (later renamed The Nigerian Stock Exchange in December 1977).
Although, several Nigerian securities have been actually listed in London before independence, it was only
in 1961 that a local market for dealing in stocks and shares was considered worthwhile and established. It
was almost an expression of nationalism and like development of its counterparts even in the
industrialized nations the Nigerian Stock Exchange was formed principally as a means for government to
raise loan finance rather an instrument for mobilizing industrial finance (Ogwumike and Omole, 1994).
With the establishment of the Lagos Stock Exchange notwithstanding there remains a large informal

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sector in Nigeria. In addition, the capital flight, which the colonial administration noticed when it arranged
for the first development stock issue for Nigeria, [sold simultaneously in London and Lagos in 1946,]
continues. Statistics provided by the Central Bank of Nigeria (1999) showing that 89.45% of the currency
in circulation is outside the banking system indicates, at the least, that past attempts at driving economic
growth in Nigeria mostly through the money market with little attention to the capital market must have
been wrongly focused. More thorough and cautious analysis is therefore needed to determine why African
stock markets have not developed to the desired level (Odife, 2000).
The development of the Nigerian market is reflected in the physical expansion and growing
activities in terms of value and volume of trade. The Nigerian Stock Market now boasts of six other
regional branches (Kaduna, 1978; Port Harcourt, 1980; Kano, 1989; Onitsha and Ibadan, 1990; Abuja)
and about 195 listed and active equity stocks, 51 industrial loan and 5 government stocks. With an initial
capitalization of less than #10 million naira at inception the stock market now boost of over #2.7 trillion.
Then with a transaction volume of #1.49 million to #521.6 million in 1989, trading now at the floor is in
the neighbourhood of #120 billion. The stock market, with a growing pool of over two million individual
investors and above three hundred institutional investors (like insurance companies, pension funds, unit
trusts and government parastatals), including foreigners who own about 47% of the quoted companies. It
has over 71 dealing members who are called stockbrokers and are licensed by the council of the Exchange
(the governing body) to trade in stocks and bonds
A regulatory body known as the Securities and Exchange Commission (SEC) established in 1978
supervises the operation of the Exchange and investigates allegations of impropriety including "insider
trading." In particular, the SEC administers prices in the primary market (sets the offer price of new
issues), regulates the operation of the stock market, as well as the registration of securities. The market is
classified into two categories (tiers) based on listing standards required by the Exchange; listing and
reporting requirements in the first tier being more stringent. Three broad classes of securities are listed on

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the exchange - Government Stocks, Industrial Loans, and Equities. The main sectoral distribution of the
listed companies are Automobile, Banking, Breweries, Building Materials (Hardware), Chemical and
Paints, Commercial, Computer and Office Equipments, Conglomerates, Construction, Food/Beverages
and Tobacco, Footwear, Hotels, Industrial/Domestic Products, Investment Companies, Machinery
(Marketing), Packaging, Petroleum (Marketing), Pharmaceutical and Animal Feeds, Publishing, and
Textiles.
The activities of the stock exchange fall into two broad categories, the primary and secondary
markets. The primary market is concerned with the initial issuance of securities. Such an issue can take any
of the following forms: offer for subscription, offer for sales, by introduction, private placement and
rights issue. The market for outstanding securities (the secondary market as it is often called) enhances the
new issues market in many ways, by providing the means by which investors can monitor the value of
their shares and liquidate them when they so desire. The secondary market augments the supply of funds
to the primary market somewhat differently. If there were no secondary market in which investors could
cash their investment in listed securities they choose, many investors may not buy new issues in the first
place. From the perspective of the overall economy, the secondary market is particularly important, as it
makes it possible for the economy to ensure long-term commitments in real capital.
With a belief on increasing patronage and creating room for smaller indigenous companies, which
could not meet the listing requirement of the first tier market, a second tier security market (SSM) was
established in April 1985 to provide a public market at reduced compliance cost for the shares of small to
medium-sized companies without the need to release more than 10% of the equity capital of the company
whilst offering most of the advantages of a stock exchange listing. This Second tier market still remain
largely underdeveloped as it boast of less than 50 active stocks and its activities is generally unreported.
Despite the aforementioned acclaimed growth (which is only in the light of comparison with similarly
Africa Exchanges), financial analysts still hold the Nigerian Stock Market as underdeveloped.

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1.10 Operational Definition of Terms
Market Capitalization: this is the market value of a company’s issued shares i.e. its share
price times the number of shares issued. Taken for a whole stock
exchange it is the summation value of the issued shares of all
quoted companies on that given exchange. For example, as at the
time of this report The Nigerian Stock Exchange Market
Capitalization value stands at # 2.7 trillion.
Market Turnover Ratio: the value of total shares or securities traded divided by market
capitalization during a given period, i.e., total value of transactions
in a given market divided by that market’s capital base.
Volatility: as regards to stock exchange; the daily share price fluctuation in a
market is known as volatility. Liability of supply and demand to
random shock and low elasticity tends to raise volatility. Generally,
developing markets are understood to exercise much more
volatility.
Liquidity: refers to the property of an asset of being easily turned into money
rapidly and at a fairly predictable price. In reference to stock
market; it is the amount of trading and turnover of shares. A liquid
stock market allows investors to buy and sell shares easily, while
still providing companies with much needed long-term capital
through equity.

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Liberalization: in the policy of a country liberalization could be in form of either
financial or trade liberalization but as pertaining to the course of
this study we are talking of financial liberalization which is the
reduction of direct controls on both internal and international
transactions and a shift towards a free-market economy. Under this
liberalization there is more reliance on price to clear market, a shift
towards self-regulatory exchange control, free foreign participating
and interest repatriation among others.
Stock Market: is an organized market or institution through which firm ownership
represented by companies’ shares and government stocks (e.g.
treasure bill, bonds) are traded. Formerly the exchange is a building
where traders (jobbers and brokers) meet to transact dealings but
modern day stock exchange has involved computer networks and
telephones. Stock market, stock exchange and equity markets are
used synonymously.
Capital Market: this is market for long-term investments and it entails the stock
markets and other institutions where securities are bought and sold.
Such securities concerned include shares in companies and various
forms of public and private debt (bills, bonds and debenture).

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Emerging Markets: this term laxly used refer to the Third World markets but
technically it is used to qualify stock exchanges in newly
industrialized countries (NICs), or newly liberalized economies.
International Finance Corporation defined such equity market as
one from developing countries.
Matured Markets: a reference for markets of First World or industrial countries thus
sometimes refers to as industrialized or developed market. These
markets are of the advanced nations.
Developing Economies: A developing economy is described as countries with less advanced
technology and/or lower income levels than the advanced
industrial countries. International Finance Corporation defined
countries with per capita income less that USD 9,656 (as at 1997) a
developing country. They are sometimes referred to as less
developed country (LDC).
Financial Intermedaries: are institutions that help lubricate the friction in financial sector by
presenting a forum of borrowing money from one set of people
and lending it to another. Banks, stock markets, discount houses,
issuing houses, and insurance agencies are example of financial
intermediaries. Financial intermediaries reduce risk and transactions
cost for both lenders and borrowers.

24
Economic Growth: takes place when there is a sustained (on-going for at least 1-2
years) increase in a country’s output (as measured by GDP or
GNP) or in the per capita output (GDP or GNP per person)
Economic Development: occurs when the standard of living of a large majority of the
population rises, including both income and other dimensions (like
mortality, literacy, education and life expectancy rates). The
distinction between economic growth and economic development
is the income is distributed; it is possible for a nation’s economic
output per person to increase (growth), but a large number of
people can have their income decrease at the same time if the
increase in output is earned by a small percentage of population.
Real GDP per capita: Gross Domestic Product (GDP) is one of the generally acceptable
measures of economic activity. It includes activities carried on in
the country by foreign-owned companies, and excluding activities
of firms owned by residents but carried on abroad. It measures real
output produced rather than output absorbed by residents.
Per Capita Income: this is national income of a country or a region divided by its
population. Per capita can be calculated per person, per adult or per
‘adult equivalent’, using weights to count children of various

25
VAR: Vector Autoregression (VAR) is an advance regression analysis
econometric tool for modelling a set of multiple time series obtain
from statistical investigation of the dynamic interrelationships
between economic variables.
Granger Causality: Analysis of Granger Causality is of the two instruments to studying
the dynamic structure of a VAR system. Granger causality
measures precedence and information content but does not by
itself indicate causality in the more common use of the term. The
fundamental idea of this definition of causality is that past and
present may cause the future but the future cannot cause the past
(Granger (1980, Axiom A)).

26
CHAPTER TWO
LITERATURE REVIEW
2.1 The Nexus of financial intermediaries and Economic growth
In the most basic civilization finance seems the life blood of any economy as a means of achieving
productions, its allocations and consumptions by the various economic units. But in the context of a
developed economic fabric exercised by modern society economic development is being accounted by
political, social and economic decisions in transforming modes of production and the social relations
associated with them (Newlyn, 1977:1). In other words, financial development is at the heart of economic
development. The contemporary complexity in the relationship of the foregoing as generated diversity in
the outcomes developmental economics studies of the past fifty years.
The post-WW2 era has witnessed a growing literature of the growth theory and development
economics most especially in the context of financial system development and contribution towards
economic advancement. Which is rooted in the work of Schumpeter first published in 1911, who argued
that financial services are paramount in promoting economic growth. In the wake of global economic
reconstruction and cooperation initiative that follows this period finance has being used in propelling the
war torn economies of second- and third-world countries towards economic reconstruction and
development; an idea evident in the International Monetary Fund (IMF) articles of agreement, which is
“to assist in the reconstruction and development of territories of members by facilitating the investment
of capital for productive purposes [and] to promote private foreign investment by means of guarantees or
participation in loans [and] to supplement private investment by providing, on suitable conditions, finance
for productive purposes out of its own capital ...”.

27
Theoretically, the traditional growth literature was not suited to explore the relationship between
financial intermediation and economic growth because it focused on steady-state level of capital stock per
worker or productivity, but not on the rate of growth (which was attributed to exogenous technical
progress). The recent revival of interest in the link between financial development and growth stems from
the insights of endogenous growth models, in which growth is self-sustaining and influenced by initial
conditions. Growth fundamentally depends on investment. Investment is financed by borrowing, which in
turn is made possible by deposits of various forms with banks and non-bank financial institutions.
Modern growth theory has emphasized the importance of other factors such as education, but the
existence of a well-functioning financial system is regarded as critical.
Proposals advanced in the body of this growth theory have sought to establish the evidence,
direction, rate and contributions of causality between the two entities. Through, there is a well-established
consensus on the role played by the financial system in an economy that the financial system enables the
more effective exchange of goods and services, mobilizes individual and corporate savings, enables the
more efficient allocation of resources and monitoring of corporate managements through capital markets,
and allows for the pooling of risk (cf Levine, 1997). It will however be acknowledged that the
aforementioned demands a pre-existence of a certain level of economic activity. Lawrence (2003) suggests
that the question is whether the importance of the financial sector is likely to arise organically out of the
process of development, or is a requirement for that development process to begin and to accelerate.
The difficulty in establishing the direction of causality between financial development and
economic growth was first identified by Patrick (1966) and further developed by McKinnon (1988) who
argued that: " Although a higher rate of financial growth is positively correlated with successful real
growth, Patrick's (1966) problem remains unresolved: What is the cause and what is the effect? Is finance
a leading sector in economic development, or does it simply follow growth in real output which is
generated elsewhere?"

28
Levine (2001) observed that diverse empirical literatures find that the level of financial
intermediary development has a large, casual effect on long-run economic performance. This evidence
emerges from firm-level studies (Demirguc-Kunt and Maksimovic, 1998), industry-level studies (Rajan and
Zingasles, 1998), country-case studies (Cameron, 1967; Haber, 1991), time-series studies (Neusser and
Kugler, 1998; Rousseau and Wachtel, 1998), cross-country studies using traditional econometric
methodologies ( King and Levine, 1993a,b), cross-country studies using basic instrumental variable
procedures (Levine, 1998, 1999), and new pooled cross-country, time-series that control for potential
simultaneity and omitted variable biases ( Beck et al., 2000: Levine et al., 2000)
Table 1 below describes details of recent studies. Of the 24 studies listed in the table, only eight
explicitly support the view that causation runs from finance to growth. Most of the others suggest either
bi-directionality or non-linearity. What is the possibility of reconciling these different findings, especially
where, in the case of ones which use time-series techniques of analysis involving co-integration and
causality tests, they come up with different results?
But it should be acknowledged that no two countries are the same and even in the studies which
broadly support the growth-to-finance chain of causation, there is evidence that this is not the case for all
countries, as is shown in the table. Lawrence (2003) further countered that the possibility that this
direction of causation may also exist in the cross-section or panel studies favoured by Levine and his
colleagues, is hidden by the techniques which group together a large number of countries and look for a
general pattern. This reinforces the point made by Arestis and Demetriades (1997: 784) who, referring to
the cross-country regressions employed by King and Levine and others, suggest that the issue of causality
is best addressed by time-series techniques on a country by country basis.

29
Table 2.1 Recent Empirical Studies on the Finance-Growth Relationship

31
Source: Peter Lawrence (2003) fifty years of finance and development: does causation matter?

32
However, Okuda (1990, p.240), earlier noted that the causal link between financial factors and
economic development is significantly dependent upon the nature and operation of financial institutions,
markets and policies pursued by individual countries. Therefore, while the findings of studies using
international panel data are informative, they also need to be complimented by individual country case
studies.
In this spite, the aim of this study is to; having the possibility of a bi-directional relationship
between these two elements in mind; explore the contributions of the capital market wing of the financial
intermediaries towards economic growth thus providing complimentary and country-specific (Nigeria)
case studies for previous studies. In other words, in the two-way link between finance and growth; in what
way and at which rate does finance contributions towards economic growth?
The web of intricacies in the complex relationship between financial and growth will not be fully
surveyed if the influence of government and bureaucratic decisions in the link is not examined. The forms
of government involvement in regulating and otherwise influencing the financial system will determine the
degree to which the latter will make a positive contribution to growth (Lawrence, 2003).
Indeed, in all forms of governments wield certain degree of interference and the effects of such
interference with financial system vary. A highly conservative government could fix ceilings for interest
rates, control credit creation, set bank reserve ratios and even nationalized banks and other financial
institutions while a most liberal government would at least regulate the financial markets to guarantee the
security of lenders. In all mostly, the government has fair intentions of interfering; Lawrence (2003) hints
that the government especially of ex-colonial countries comes in, in rescuing financial assets from foreign
companies domination because their primary interest is mostly private profit and not long-term
investment. Also, governmental influences are exercised in extending lending opportunities to many more
potential borrowers against the banking usual practice of lending only to proven credit-worthy customers.

33
Meanwhile, in underdeveloped economies much of the initial development investment to build the
infrastructure and to stimulate growth by setting up state enterprises come from the state, then
governments would have to direct the financial sector towards this development objective. Newlyn and
Rowan (1954) added that in mobilizing savings there is high transactional cost of organizing deposit
facilities for large numbers of poor people who saved little and this meant that governments had either to
take control of commercial banks in promoting branch expansion or had to establish institutions to
organize the savings of low income groups. In poorly developed economies the state is usually the
dominant economic actor and engages in a process of long-term development management.
Finally, in whatever economy intermediaries are needful and exist in the financial machinery to
galvanizing economic activities. The financial system through its intermediaries of capital- and money-
markets helps in lubricating some exchanges’ frictions in the economic cycle. According to Nieuwerburgh
et al (2005) first, financial intermediaries facilitate pooling and trading of risk which allow the economy to
invest relatively more in the risky productive technology and this spurs economic growth. Second, they
improve on the allocation of funds over competing investment projects by acquiring information ex-ante.
Afterward, projects with informational advantage enjoyed investment funds.
Ex-post monitoring of management and exertion of corporate control also induces the need for
financial intermediaries (Williamson (1986)). The financial intermediaries here serve as the mechanism
with which investors maintains the balance in principal-agent relationship with the management in
fostering better performance. Financial markets also mobilize savings and increase specialization. These
intermediaries stimulate specialization in the economy and hence growth by reducing financial transaction
costs.
Notably, the money market and capital market make up the divergent schism of present-day
financial intermediaries. Economists have constructed a vast number of theoretical insights into the
comparative advantages of different financial systems. Reflecting these, policymakers continue to struggle

34
with the relative merits of bank-based versus stock market-based financial systems in making policy
decisions. The point of which is outside the scope of this study.
2.2 A Synopsis of global equity market– Kai Li’s Perspective.
Because of the aggressive nature of modern civilization in the name of globalization which parades
a highly integrated financial system it will be prudent enough for the course of this study to have an
overview of global equity market. Over the past thirty years, stock markets worldwide have experienced
phenomenal expansion. The aggregated market capitalization of all national equity markets surged from
less than US$1 trillion in 1974 to about US$6 trillion in 1986 and to over US$16 trillion in 1997. The
growth rate for world market capitalization is about 15% per annum. And, according to Marber (1998) the
First World’s financial markets are estimated at approximately $17 trillion in equity and $25 trillion in debt
as at 1998, versus the Third World’s tiny $2 trillion in equity and $1.5 trillion in debt.
Levine (1997) however contested that the proportion of worldwide stock market capitalization
represented by emerging markets jumped more than threefold. Furthermore, the total value of stock
transactions in emerging economies soared from about 2 percent of the world total in 1986 to 12 percent
in 1996. The rapid emergence of markets in developing countries was accompanied by an explosion in
international capital flows, especially to those markets. Net private capital flows to developing nations
jumped tenfold over the past decade and exceeded $250 billion in 1996 (World Bank, 1997). And in 1999,
66% (more than USD 600 billion) of the capital involved in foreign direct investment went to emerging
equity markets as evident from the figure below. Whereas equity flows represented a negligible part of
capital flows to emerging markets a decade ago, equity flows now represent about 20 percent of private
capital flows to developing nations.

35
Figure 2.1
Nevertheless, Li (2002) affirmed that the process of growth in global equity markets is still
imperfectly understood. One view points to improved macroeconomic and financial fundamentals as the
source of the growth. Others, more sceptical of efficiently functioning markets, question whether
fundamentals have improved sufficiently to justify this phenomenal growth, and suggest that global
investors in their exuberance may have been buying up stocks in disregard of the historical relationships
between market fundamentals and equity valuation.
According to him, growth of equity markets can be thought of in terms of three different
components, namely a) reduction in market inefficiency (i.e., decrease in under pricing), b) changes in
valuation technology, and c) improvements in market (macroeconomic and financial ) fundamentals.
Using stochastic productions frontier models of valuation factors (Macroeconomic and Financial)
fundamentals and efficiency factors (legal, regulatory and institutional) framework in panel data on 32
countries, he shows that a large part of the growth in equity markets is achieved by obtaining higher
valuation from given levels of market fundamental rather than from improved fundamentals or from

36
elimination of market inefficiency. One interesting finding is that changes in valuation technology, not
apparently related to a country’s economic fundamentals or its institutional framework, appear to have
played an important role in phenomenal expansion of global equity markets relative to GDP over the past
three decades.
He also illustrated that for developed countries the size of equity markets is positively related to
correlation of these markets with the global portfolio, and that it is negatively related to government
consumption. For emerging market countries, the level of financial intermediary development and
openness to trade are found to be conducive to the development of local equity markets but
improvements in valuation efficiency are discovered to vary, particularly in emerging market countries,
which have rarely significant role in explaining the growth of equity markets.
Furthermore, he ascertain that ceteris paribus, developed countries with greater economic freedom and
stronger shareholder protections are associated with more highly valued equity markets, while French and
German civil law countries and countries with established insider trading laws tend to have relatively
poorly valued equity markets. For emerging market countries, ceteris paribus, high quality of accounting
standards is found to be associated with more efficient valuation. He concluded that it appears that
Australia, Canada, the United States, Hong Kong, and Singapore have the most highly valued equity
markets in the developed world, while Malaysia has the most highly valued equity market in the
developing world.
Finally, Kai Li suggest that when judging the soundness of a country’s equity market they should
focus more on the determinants of equity market capitalization, such as a country’s economic
fundamentals and its institutional framework, rather than the market size itself which is prone to
speculative attacks driven by the inexplicable market sentiment. He, however, advices that one way for
countries to insure against the capriciousness of stock market is to diversify sources of financing through
foreign direct investment, public and private placement of debt, and syndicated bank loans.

37
Consequential to the above, a plethora of studies now focus on how to measure the benefits of globally
diversified portfolios, while a large number of countries expound regulatory reforms to foster capital
market development and attract foreign portfolio flow. Demirguc_Kunt and Levine (1996) approved that
stock market size, liquidity, and integration with the world capital markets may affect economic growth.
2.3 Emerging Stock Market- Operational Analysis
The term "emerging market" implies a stock market that is in transition, increasing in size, activity,
or level of sophistication. Most often the term is defined by a number of parameters that attempt to assess
a stock market’s relative level of development and/or an economy’s level of development.
In general, Standard and Poor (S&P) classifies a stock market as "emerging" if it meets at least one of
several general criteria:
A. it is located in a low or middle-income economy as defined by The World Bank,
B. it does not exhibit financial depth; the ratio of the country’s market capitalization to its GDP is
low, there exist broad based discriminatory controls for non-domiciled investors, and/or
C. It is characterized by a lack of transparency, depth, market regulation, and operational efficiency.
These attributes may be underscored by the following characteristics:
1. Lack of availability of timely and accurate information regarding corporate actions, stock prices,
and shareholder ownership, all of which indicate transparency of the market.
2. Lack of a strong regulatory authority, which articulates and implements clearly defined laws for
governing the equity markets. The laws should ensure rights of minority shareholders.
3. Absence of a well developed futures and/or options market.
4. Lack of a trading system that allows and encourages stock lending, trading of “shares in kind” and
short selling.
5. Trade settlement procedures may not be simple and low cost.

38
6. Presence of some special limiting procedures for foreign investors to register and trade in the
market.
Until 1995, the index definition of an emerging stock was based entirely on The World Bank’s
classification of low and middle-income economies. If a country’s GNI (gross national income) per capita
did not meet The World Bank’s threshold for a high-income country, the stock market in that country was
said to be "emerging". More recently this definition has proven to be less than satisfactory, due to wide
fluctuations in dollar-based GNI per capita figures. Dollar-based GNI figures have been significantly
affected by the amplitude in exchange rate fluctuations, particularly in Asia. Moreover, reported GNI
figures, which take significant time to prepare, are often out-of-date by the time of public release.
Accordingly, S&P has adopted new and more far-reaching criteria to classify a market as
“developed” or “emerging”. To graduate from emerging status, GNI per capita for an economy should
exceed The World Bank’s upper income threshold for at least three consecutive years. This three-year
minimum limits the possibility that the GNI per capita level is biased by an overvalued currency. Another
typical characteristic of an emerging stock market is its relatively small investable market capitalization
relative to gross domestic product. Investable market capitalization is a market’s capitalization after
removing holdings not truly "in the market" for foreign institutional investors. Non-investable holdings
include, but are not limited to, large block holdings and parts of companies that are inaccessible due to
foreign investment limits. For a market to graduate from the emerging market series, it should have an
investable-market capitalization-to-GDP ratio near the average of markets commonly accepted as
developed for three consecutive years.
Stock markets that maintain or introduce investment restrictions such as foreign investment limits,
capital controls, extensive government involvement with listed companies, and other legislated restraints
on market activity, (particularly those pertaining to foreign investors), are generally considered emerging

39
markets. Pervasive restrictions on investment by non-resident investors do not generally exist in
developed stock markets, and their presence is a sign that such markets may not yet be "developed".
There are also numerous qualitative features to consider when inspecting specific stock markets. Issues
such as operational efficiency, quality of market regulation, supervision & enforcement, corporate
governance practices, minority shareholder rights, transparency & disclosure, and level of accounting
standards are important characteristics for investors to consider in their tolerance for any pronounced
emerging market exposure.
2.4 Emerging Equity Markets – Embryos or Casinos?
The schism of global equity markets into the species of “developed/matured” and “emerging”
markets according to International Finance Corporation does not depend on the level of its stock market
development or other economic institutions, but instead merely on whether its GNP per capita is below
or above the World Bank’s threshold for a “high-income country” (USD 9,656 in 1998). Beim and
Calomaris (2001), however, noted that emerging markets is a curious term suggesting that the financial
markets in developing countries were underground, underwater or otherwise hidden from the world. They
aver that financial markets in developing markets have existed for long time. Marber (1998) in a
supporting intonation reiterate that this once called “undeveloped”, later called “underdeveloped”, later
still known as “ least developed”, and finally, more optimistically, as “developing”, these countries have
turned a definite corner: they are now emerging markets. To him, no longer are they looked upon as the
laggards: now the name “emerging” reflects their potentials. The term emerging markets probably suggest
a movement away from statism and highly regulated markets and towards freer markets. In other words,
these developing countries abandoned decades of inward-looking policies of statist and collectivist
governments and now embrace the neo-liberal economics of the West.(Marber, 1998)

40
A common ground is that an emerging equity market is an equity market from a developing
country but the controversy lies in the view of some analysts of the emerging equity markets as casinos
where investors exercise “irrational exuberance” based on market sentiment in their favour. They are of
the opinion that these markets are susceptible to high volatility, limited market capitalization thereby
illiquidity, much more sensitive to global equity market shocks, risk of political and economic instability,
and Irving (2000) believe that they expose already fragile developing economies to the destabilizing effects
of short-term, speculative capital inflows.
In correcting this outlook Levine and Zervos (1998) researching into whether stock markets are
merely burgeoning casinos or a key to economic growth vindicate that there is significant correlation
between stock market development and long run growth. Although, earlier Levine (1997) has argued that
stock markets in developing countries account for a disproportionately large share of the boom in global
stock market. Marber (1998) contended that no market are truly risk free and despite the high risks of
these Third World investment investors in such markets have been overcompensated he believes that
such investments helps in lowering the overall portfolio risk.
There is no doubt that the scenarios obtainable in today’s emerging market mirror the initial
development in what is now known as developed markets which is inevitable in such growth. The
reverberating memories of Black Monday (October 19, 1987), Black Friday (September 19, 1873) and
stock market crash of the 1930s remind one of the susceptibility of today’s matured markets to economic
shocks in their developing era. And the phobia entertained today about emerging markets and their
respective economies in which their stock markets have been labelled casinos emanated from high
venerability developing world economies to macroeconomic shocks and their vicious measures in
countering the consequences thereof which cost foreign investor lots in capital.
For instance, countries like Poland, Peru, Bolivia, Costa Rica, Dominican Republic, Honduras,
Zaire, Ivory Coast, and Zambia among others defaulted heavy in their debt servicing in the 1980s

41
(Kaufman, 1988). Argentina and Brazil average an inflation rate of over 1000% from 1985 to
1991(International Monetary Fund, International Financial Statistics Yearbook, 1991). Cuba, Peru, Chile
and several African countries nationalized in the 1950s, 1970s and 1980s and many companies lost
millions in property. Capital flight grew from $20 billion in 1979 to $40 billion in 1981, and swelled to
$100billion by 1987 (The Economist, 1993). Nonetheless, in the face of 1980s woes, World Bank still
report an average growth rate of 4.7% for emerging markets between 1965 and 1989 compared with 3.1%
for industrialized countries.
Mohtadi and Agarwal (2000) found in their study, focused exclusively on emerging stock markets,
that the development of such markets as with their developed counter parts is positively associated with
economic growth. This validates Levine and Zervos (1998) submission that there exist a positive and
significant correlation between stock market development and long-run growth in developing economies.
Although, Pragmatic research has shown that emerging stock markets tend to have lower stock return
correlation coefficients with the developed stock market. This fact makes emerging markets a good
vehicle for portfolio diversification.
It will be acknowledged that it is an equitable conclusion that the probable high cost that comes
along with trading in emerging markets is a considerable price being paid for their huge returns thereof
which sophisticated investors have learnt to reduce. Agreeing with Marber’s conclusion on this matter, like
developing economies themselves, emerging markets lie in the chrysalis between a caterpillar and a
butterfly, a unique transitional period. In other words, casting towards the present form of their developed
counterparts, emerging equity markets not embryos but imagos and surely not casinos but with better
understanding of the economic atmosphere, legal terrain and political construction of such developing
countries, their stock exchange are burgeoning key in economic growth.

42
2.5 Evolution of Emerging Markets – The Faber’s Theory.
Investors, economists, analysts and policymakers with the bias that these markets are budding are
interested in having a vista of the growth process-life cycle of an emerging market and to be able to
determine the attained-stage of such markets in its development cycle. Obviously, a retrospect of growth
life of now developed market would have been a helpful reference but individual countries political, social
and cultural make up are contributory and therefore relevant in the interpretation of emerging markets.
Through in economic history, there is hardly a perfect theory that exactly predicts situations for which
they are built but the Faber’s theory has been outstanding. This theory by Dr. Marc Faber; a renowned
Hong-Kong base fund manager, was first published in Barrons 1992. it Incorporates not economic
conditions but, also, socio-political concepts into his interpretation of the evolution of emerging markets.
This theory is worth judicious consideration in that its efficacy has been proved by its prediction of the
downturns in Asia years before the markets actually fell hard in 1997.
With witty and anecdotal observance, Faber believes that the key to investing wisely in emerging
stock markets is to identify where countries are in their individual social, political, and economic
developmental cycles. Faber identify seven phases in the growth wave pattern of an emerging market.
Phase Zero: is characterized by economic stagnation, unstable economic and social conditions, and little
foreign direct or portfolio investment. He believes headlines from such countries are negative, hotel
occupancy and tourism are low, and the stock market is cheap and illiquid. Argentina and Philippines
witnessed this chapter in mid-1980s, and between 1985 and 1990 respectively.
Phase 1: here there are significant positive changes occur (e.g. new government or new economic policies).
General economic conditions improve, and consumption rises, exports increase, as does capital spending
and corporate profit. Foreign direct investments flow in, capital is repatriated, stocks, along with tourism

43
pick up and foreigners become interested in joint ventures and other investments, while tax laws are
changed to encourage and attract these entities. Argentina after 1990, Mexico after 1984, China after 1978
are classical examples of this phase.
Phase 2: the economic expansion in phase one above leads to lower unemployment, higher wages, and
more foreign funds. Positive sentiments prevail, perhaps to a fault, as the improvements are perceived to
be everlasting, and capital spending to expand capacity soars to dangerous levels. Great expectations fuel
the boom, and everyone jumps on the bandwagon. Meanwhile, markets are soaring but like human babies,
these markets are “accident-prone” and susceptible to crashes. Japan and Thailand between 1987 and
1990 experienced this period.
Phase 3: although the boom seems ongoing, ultimately overinvestment leads to excess capacity and real
estate, infrastructure problems, and strong inflation pressures, all of which culminate in a shock and an
unexpected decline in stock price. To him, this marks the beginning of a mature stage, where markets lose
energy and gain volatility. This is the situation in Japan, Thailand and Indonesia after 1990.
Phase 4: here, while the economy appears to be fine, profit margins are decreasing, and growth is slowing.
Stocks revive as new foreign investors, thinking the slowdown is temporary, seek “missed” opportunities.
Stocks fail to reach new highs as the large numbers of new issues outstrip demand, while political and
social conditions start to deteriorate, and hotels are forced to offer discounts with declining tourism. Japan
and Thailand in 1991 went through this period.
Phase 5: corporate profits and stocks plummet, and consumption grinds down. As markets turns bearish,
investors finally recognize their past miscalculations, realize that they overpaid for stocks, begin to unwind

44
leveraged positions, and accelerate the decline by rushing to get out of the market. Capital spending and
real estate prices fall. A regression, or perhaps progression, to phase 1 or 2 is around the corner. Japan and
Thailand in 1992.
Phase 6: investors abandon stocks, capital spending fall, foreigners exit the local markets (and begin
speculating against them), and the currency weakens or is devalued. Compared to Phase 3, the mood is
pessimistic, confidence fades, and fear takes over. In the prosperous phases, everyone wanted in; now
everyone wants out. Asia in the 1990s is an example.
According to Marber (1998) the wisdom in Faber’s approach underscores the importance of
country analysis and timing. The trick is to accurately identify when the overall trend in confidence has
shifted, which ultimately will affect liquidity and price formation. But this trend plausibly arose the
question that if an average emerging market follows the Faber’s prescribed circuit when will it be
identified as a developed market? But recent evidences from Tokyo (Japan) stock exchange (once
acclaimed mother of all emerging markets) has provided that with well developed level of industrialization,
economic sophistication, and accentuated political and social inclination a market is categorized as
matured..
2.6 Emerging Stock Markets and Economic Growth - Characteristics & the Channels of
Contribution.
Still bearing in mind the percept that the relationship between financial development and
economic growth is bi-directional and here accounting only for the side from finance towards economic
growth in the context of stock market contributions towards economic growth, I will now consider the
auxiliaries of the stock market in achieving this end.

45
Motivated by King and Levine (1993) paper on the evidence of how financial system promote
growth; researchers in the last decade have focused on showing specific channels through which financial
institutions development leads to growth. Levine and Zervos (1998) suggest that stock market liquidity
along with banking development is both positively correlated with economic growth. Wurgler (2000) finds
that financial markets (stock market inclusive) improve capital allocation, and Beck et al. (2000) show that
financial intermediaries (equity market as well) increase total factor productivity. Using a comprehensive
panel data set on emerging markets, Bekaert et al. (2001, 2002) concluded that capital market liberalization
spur growth.
Erstwhile, some literatures have called attention to some ingredients that catalyzed the
development of the stock market, itself and thereby affect economic growth. Perotti and van Oijen (2001)
show that privatization leads to more developed stock markets, and La Porta et al. (1997, 1998) illustrate
that the legal environment matters for corporate governance and the size and extent of a country’s capital
markets.
Hereby, in studying the contributions of stock market towards economic growth, the mechanism
through which it dictates the pace and path of economic growth would be analyzed. Bearing the evidences
of available finance literature which have acknowledge a long-term influence towards economic
development the major channel of contribution of the stock exchange lies in these paramount characters
of legal environment, liberalization, liquidity, and volatility as well as its nature of integration with the
global market.
2.6.1 Legal, Regulatory, and Institutional Framework
As aforementioned, the forms of government involvement in regulating and otherwise influencing
the financial system will determine the degree to which the latter will make a positive contribution to

46
growth (Lawrence, 2003). Legal and institutional systems are parts of any country’s sovereign structure
and which affects the constituents of such structure of which the capital market is not excluded.
Empirical examination of the relationship between legal systems and capital markets have ascertain
modest influence in the least. For example, in a series of cross-country studies, La Porta et al. (1997, 1998)
find that the legal environment matters for the size and extent of a country’s equity market; exhibiting that
in terms of protection against expropriation by insiders, common law countries protect shareholders the
most, French civil law countries the least, and German and Scandinavian civil law countries somewhere in
the middle. Demirguc-Kunt and Maksimovic (1998) show that difference in legal and financial systems
affect firm’s use of external financing concluding that firms in countries with high ratings for the
effectiveness of their legal systems are able to grow faster by relying more on external finance. Lombardo
and Pagano (2000) find that there is a positive cross-country correlation between the quality of legal
systems and the expected return on equity.
Furthermore, Dyck and Zingales (20020 show that high degrees of statutory protection of
minority shareholders and law enforcement are associated with lower levels of private benefits of control;
especially that insiders in French civil law countries possess systematically higher private benefits of
control than those in countries of other legal origins, and Leuz et al. (2202) find that companies in Anglo-
American countries with arm’s length institutional features, exhibit less earnings management than their
Continental-European counterparts with insider institutional characteristics which undermines financial
market development. Bhattacharya and Daouk (2002) find that the enforcement of insider trading laws
reduces a country’s cost of equity.
In theory, the legal and institutional framework may have both direct and indirect effect on the
equity market development. The direct effect occurs because better legal systems and institutions
strengthen property rights and government reliability, thus broadening the appeal and confidence in equity
investment leading to highly valued equities and thus larger stock markets. The indirect effect occurs

47
because better legal systems and institutions also spur economic growth and improve market
fundamentals, thus leading to a higher valuation frontier. (Li, 2000).
Justifying the above, Kai Li (2000) in his study employed stochastic production frontier modelling
framework which explicitly accounts for both effects. In the model “efficiency factors” which embody the
legal and institutional characteristics of a country that directly affect the distance of its market
capitalization from the frontier, and “valuation factors” which embody the indirect effect of market
fundamentals that result from legal system and institutions, defined the valuation frontier, and thus he
found out that they affect the size of a country’s equity market.
Prevailing quality of accounting regulatory standard in terms of general information, income
statement, balance sheet, funds flow statement, accounting policies, stockholders’ information, and
supplementary information (reveal in companies’ annual reports) have also been shown to affect valuation
of respective countries’ equity. High quality of accounting standards is strongly associated with more
efficient valuation (Li, 2002).
2.6.2 Liberalization of the Stock Market
Choosing the course of financial or even trade liberalization is always a controversial affair for
policymakers of any country most especially developing countries. And choosing this course and its
consequences or contributions to economic growth has generated yet unresolved debate in financial
liberalization literature. Prior, Financial Liberalization suggest reduction of impediments to international
capital flow, which might involve easing restrictions on capital flows or reducing limitations on
repatriating dividends or capital. In other words, it is integration to the prevailing international financial
system.
However, the daunting question is will policies that encourage international financial integration
spur long-run economic growth most importantly in developing countries? While, The World Bank,

48
International Monetary Fund, and the World Trade Organization believe the answer is “yes”, Paul
Krugman (1993) concludes that the answer is “no”. Paul argues that international financial integration is
unlikely to be a major engine of economic development. Drawing this conclusion after noting that (a)
capital is relatively unimportant for economic development, and (b) large flows of capital from rich to
poor countries have never occurred. According to Levine (2001), his view suggests that a developing
country that liberalizes international financial interactions is unlikely to boost domestic capital formation,
even if foreign funds substantially increase the domestic capital stock; it will only ignite a depressingly
small amount of long-run growth. Levine point out that Krugman disagrees with all of the building blocks
of a traditional argument for international in developing countries.
In studying the above question, after an extensive survey on the empirical literature relating
liberalization and growth, Prasad et al. (2003) point out the following. First, they note that it is difficult to
establish a robust causal relationship between the degree of financial integration and output growth
performance. Second, they indicate that there is little evidence that financial integration has helped
developing countries to better stabilize fluctuations in consumption, which is a better measure of well-
being than output. In the end, they conclude that while there is no proof in the data that financial
globalization has benefited growth; there is evidence that some countries may have experienced greater
consumption volatility as a result. Expositions from related studies Rodrik (1998) and Kaay (1998) find no
significant relationship in contrast, Quinn (1997) showed a positive relation between capital account
liberalization and economic growth, conditioning on the level of industrialization (Klein and Olivei
(2000)), the level of development of an economy find a positive effect of capital account liberalization on
growth. Bekaert and Harvey (2000) also examine the relationship between economic growth and
liberalization at very short horizon and find a positive association.
Tornell, Westermann, and Martinez (2004) studied 52 economies from 1980-1999 to answer the
question of financial liberalization, crises, and growth. They point out that in developing countries, (1)

49
financial liberalization indeed leads to financial fragility and incidents of crises, but (2) financial
liberalization also has led to higher GDP growth. In fact, faster-growing countries are typically those that
have experienced boom-bust cycles. Their conclusion is that occasional crises are the by-product of
financial liberalizations that eventually enhance economic growth. Earlier, Bekaert, Harvey and Lundblad
(2001) in studying equity market liberalization found that average real economic growth increase between
1 and 2% per annum after a financial liberalization.
Using existing theory and evidence in contesting Krugman’s pessimistic conclusion, Levine (2001)
found that liberalizing restrictions on international portfolio flows tends to enhance stock market liquidity,
which in turn accelerates economic growth primarily by boosting productivity growth.
Hence, singling out stock market liberalization from financial liberalization has largely been proved to be
averagely beneficiary to economic growth. Equity market liberalization is a decision by a country’s
government to allow foreigners to purchase shares in that country’s stock market. The political uncertainty
and barriers to the free flow of capital and goods were behind the reticent attitude of the international
investor towards the emerging markets during the 70s and 80s. Poor disclosure laws and bureaucratic
delays make it expensive to obtain timely relevant corporate information. A more democratic political
climate and liberal reforms, however, have created the growth. In addition, competition of regional stock
exchanges to attract foreign investment has pushed for very liberal attitudes towards foreign investors.
The liberalization of stock exchanges is an ongoing phenomenon.
Henry (2000a) studying a sample of 12 emerging countries examined in this paper, stock markets
experience average abnormal returns of 4.7 percent per month in real dollar terms during an eight-month
window leading up to the implementation of a country’s initial stock market liberalization. After
controlling for co-movements with world stock markets, economic policy reforms, and macroeconomic
fundamentals, the average abnormal return, 3.3 percent per month over the same horizon, is smaller but
still economically and statistically significant. Bekaert and Harvey (2000), and Henry (2000a and 2000b)

50
provide evidence that the cost of capital may have decreased and investment increased after capital market
liberalization.
Furthermore, Henry (2003) finds that stock market liberalization in emerging markets decreases
the aggregate dividend yield (the cost of capital), increases the growth rate of capital by 1.1% and per
worker output by 2.3% per year. At the firm level, Chari and Henry (2002) find that stock market
liberalization increases the growth rate of firms’ capital stock. Bekaert, Harvey and Lundblad (2001a)
found that stock market liberalization led to a 1 percent increase in per capita GDP growth over a five-
year period. They argued that the set of variables that control for variation in economic growth rates
across countries and not accounted for by equity market liberalization fall into three categories:
macroeconomic influences, banking development, and equity market development.
Figure 2.2 Changes in Stock Market Liquidity and Volatility Following Liberalization of Controls on
International Portfolio Flows
Note “+” indicates significant increase; blank space indicates no significant change; NA indicates data not available.
Source: Ross Levine and Sera Zervos, “Capital Control Liberalization and Stock Market Development”

51
The political uncertainty and barriers to the free flow of capital and goods were behind the reticent
attitude of the international investor towards the emerging markets during the 70s and 80s. Poor
disclosure laws and bureaucratic delays make it expensive to obtain timely relevant corporate information.
A more democratic political climate and liberal reforms, however, have created the growth. In addition,
competition of regional stock exchanges to attract foreign investment has pushed for very liberal attitudes
towards foreign investors. The liberalization of stock exchanges is an ongoing phenomenon.
Nevertheless, some policymakers fear that opening up domestic stock markets to foreign investors
increases the risk that share prices will become more volatile as cash fluctuates with good or bad
economic news. Such gyrations would complicate macroeconomics and exchange rate policies, while
potentially deterring local companies from making long-term investments. Figure 2.2 above lists 14
countries that liberalized controls on international portfolio flows. In 12 of the 14 countries, stock market
liquidity rose significantly following the liberalization of international investment restrictions. None of the
14 countries experienced a statistically significant fall in liquidity following liberalization. It is also true that
stock market volatility rose in 7 out of 11 cases for a few years following liberalization (Figure 2.2).
Volatility did not fall significantly in any of the cases. Thus, while raising stock market liquidity, capital
control liberalization tends to be associated with increased volatility. In the long run, however, greater
openness to international capital is associated with lower stock return volatility. So, the jump in volatility
following liberalization is a transitory phenomenon (Levine and Zervos, 1998b). It is agreed that, if
policymakers have the patience to weather some short-run volatility, liberalizing restrictions on
international portfolio flows offers expanded opportunities for economic development.
Moreover, capital control liberalization may improve the ability of firms to raise capital, both by
improving the liquidity of domestic exchanges and by providing greater access to foreign exchanges
(Levine, 1997). In summary, the evidence suggests that policymakers in emerging markets should take
steps to provide greater access to their equity markets because it will enhance the likelihood that their

52
citizens will enjoy better living conditions in the future. While it is true that stock market development
does not represent a financial elixir for economic growth, liquid stock markets can be an important
contributor to growth, and liberalizing restrictions on international portfolio flows is an effective way of
improving access to well-functioning equity markets
2.6.3 Liquidity of the Stock Market
Liquidity is the bedrock of stock market development. This entails the flexibility of entering and
exiting from the market or an available investment window. It is generally upheld that stock market affects
economic activity through the creation of liquidity of capital investment because many profitable
investments require a long-term commitment of capital, but investors are often reluctant to relinquish
control of their savings for long periods. Liquid equity markets make investment less risky-and more
attractive-because they allow savers to acquire an asset-equity-and to sell it quickly and cheaply if they
need access to their savings or want to alter their portfolios. At the same time, companies enjoy
permanent access to capital raised through equity issues. As savers become comfortable with investing for
the long term in equities, they are likely to rebalance their portfolios toward equities and away from
shorter-term financial investments. For firms, this rebalancing lowers the cost of shifting to more
profitable-that is, more productive—longer-term projects (Levine, 1997).
This seems the only area of stock development literature where policy makers and financial
economists agree with moderate doubts. Of course the contribution of liquidity itself to long-term growth
has been questioned. Demirguc-Kunt and Levine (1996) point out that increased liquidity may deter
growth via three channels. First, it may reduce saving rates through income and substitution effects.
Second, by reducing the uncertainty associated with investments, greater stock market liquidity may reduce
saving rates because of the ambiguous effects of uncertainty on savings; third, stock market liquidity
encourages investor myopia, adversely affecting corporate governance (Liquid markets may weaken

53
investors’ commitment and reduce investors’ incentives to exert corporate control by overseeing managers
and monitoring firm performance and potential) and thereby reducing growth. However, on the opposite
side of the last issue--that of corporate governance--Jensen and Murphy (1990) argue that in well
developed stock markets tying managers’ compensation to stocks is an incentive compatible design that
aligns the interests of principles (owners) and agents (managers), thereby spurring efficient resource
allocation and economic growth.
Recent findings have confirmed earlier theories that postulated that the liquidity provided by stock
markets raises the productivity of capital on an economy-wide level it facilitates loner-term, profitable
investment. While, Levine and Zervos (1998a) suggest that stock market liquidity is positively correlated
with economic growth Obstfeld (1994) shows that international risk sharing through internationally
integrated stock markets improves resource allocation and accelerates growth. Bencivenga, et. al. (1996)
and Levine (1991) have argued that stock market liquidity plays a key role in economic growth. Liquidity
has also been shown to increase investor incentive to acquire information on firms and improve corporate
governance (Kyle, 1984; Holmstrom and Tirole, 1993), thereby facilitating growth.
Figure 2.3 Economic Growth of Countries between 1976 and 1993 by Stock Market Liquidity in 1976*
(Annual Percent Growth Rate of Per Capita (1976-1993)
*Stock Market liquidity is measured as the ratio of the value of trade transactions to GDP in 1976.
Source: International Finance Corporation’s Emerging Markets Database
An IFC report, using for 38 countries a value-traded ratio (i.e. the total value of the trading
volume of a country’s stock exchanges expressed as a share of the country’s gross domestic product

54
(GDP).), and hereby in Figure 2.3 groups the countries by the liquidity of their stock markets. The first
group has the nine most illiquid markets; the second group has the next 10 most illiquid markets; the third
group has the next 10; and the final group has the nine countries with the largest value-traded ratios.
Those countries with relatively liquid stock markets in 1976 experienced GDP growth that was much
faster over the subsequent 18 years than countries with illiquid markets. Moreover, countries with the
most liquid stock markets in 1976 both accumulated more capital and enjoyed faster productivity growth
over the next 18 years. Liquidity thus boosts both the quantity and productivity of capital investment,
both of which accelerate economic growth (Levine, 1997).
To understand liquidity, one must keep in mind two dimensions: one, the existing cash available in
a local marketplace, and, two, new capital flows, whether internally or externally generated (Marber, 1998).
Yet, alternative measurements of stock market liquidity provide the same conclusion. For instance, market
liquidity measurement as turnover ratio (which equals the total value of shares traded as a share of market
capitalization) and as the value-traded ratio divided by stock price volatility proffer also as good economic
growth forecasters (Levine, 1997). Other measures of stock market development appear not to account
for economic growth as well as liquidity. Liquidity exhibits the strongest connection to long-run growth.
The link between liquidity and economic growth is not simply the result of liquidity serving as a proxy for
other sources of growth. Levine concluded that the relationship between liquidity and growth remains
strong even after controlling for inflation, fiscal policy, political stability, education, the efficiency of the
legal system, exchange rate policy, and openness to international trade. Thus, raising stock market liquidity
may independently produce sizable growth dividends
2.6.4 Volatility of the Stock Market
This is the most technical and fragile side of stock market whose frequency has aroused the most
unsettled controversy about emerging stock market. Ever since Shiller [1981], economists have sought to

55
understand the origins of volatility in stock market prices, which appears to exceed the predictions of
simple models with rational expectations and constant discounting. Ordinarily, increase volatility seems
one of the immediate or short-run consequences of stock market or capital control liberalization.
Investors, over the decades have watched this daily price fluctuation with voracious trepidation as it
dictates the value and the yields of their investments at any particular time.
For some researchers in financial economics, the interesting question is: what drives the volatility
itself? The evidence they have uncovered over the last few decades sheds light on the efficiency of the
stock market and points to some important implications for economic forecasters and investors. In
particular, it suggests that the degree of stock market volatility can help forecasters predict the path of the
economy’s growth; furthermore, changes in the structure of volatility imply that investors now need to
hold more stocks in their portfolios to achieve diversification (Krainer, 2002).
Stock market performance is usually measured by the percentage change in the stock price or
index value, that is, the returns, over a set period of time. One commonly used measure of volatility is the
standard deviation of returns, which measures the dispersion of returns from an average. If the stock
market is efficient, then the volatility of stock returns should be related to the volatility of the variables
that affect asset prices (e.g. dividends). But research conducted in the early 1980s suggests that variation in
dividends alone cannot fully account for the variation in prices (see LeRoy and Porter 1981 and Shiller
1981). Prices are much more variable than are the changes in future dividends that should be capitalized
into prices. Hence, Krainer (2002) agrees that asset prices apparently tend to make long-lived swings away
from their fundamental values. This fact turned out to be equivalent to the finding that, at long horizons,
stock returns displayed predictability. Thus, the literature on excess volatility broached the possibility that
the stock market may not be efficient.
Stock market volatility tends to be persistent; that is, periods of high volatility as well as low
volatility tend to last for months. The persistence in volatility is not surprising: stock market volatility

56
should depend on the overall health of the economy, and real economic variables themselves tend to
display persistence. The persistence of stock market return volatility has two interesting implications. First,
volatility is a proxy for investment risk. Persistence in volatility implies that the risk and return trade-off
changes in a predictable way over the business cycle. Second, the persistence in volatility can be used to
predict future economic variables. For example, Campbell, et al. (2001) show that stock market volatility
helps to predict GDP growth.
In general, the developing markets are held to have much more volatility than industrialized
markets. Historic volatility for such developed markets is average in 15% range per annum, when
measured by standard deviation of daily returns. Very few of the G7 markets would experience greater
volatility because most of their economies are relatively balanced and predictable (Marber, 1998). One the
other hand, as it is obtainable for Figure 6 below, the average volatility of an emerging market more than
double the developed markets average and in some cases, about five times the average. The daunting
question is why this high volatility in emerging markets which is as well associated with consequential
great risk? Marber provides an answer in that when markets are nascent and thinly capitalized, a sudden
rush of cash (probably accounted for by Liberalization) will immediately affect prices. Since the resulting
liquidity is sentiment driven, prices can quickly change with perceptions of political, economic, or social
turbulence as experienced in Asia in late 1990s. Similarly, Kim and Singal (2000) argue that foreign
investors are quick to react to changes in short-term economic outlook in emerging economies, making
unrestricted capital flows very volatile. This volatility of capital flows may increase the volatility of the
stock market.

57
Figure 2.4 EMERGING STOCK MARKETS VOLATILITY
IFCI Annualized Standard Deviation*
80
62
52
40 38 38 36 36 33 31 30
26 25 25 24 24
19
15
9 9
0
20
40
60
80
100
Poland
Venezuela
Pakistan
Columbia
China
Mexico
Peru
Zimbabwe
Thailand
India
Indonesia
Korea
Japan,
Nikkei
Malaysia
Chile
South
Africa
Portugal
IFCI
Composite
UK,FT100
USS&P
500
* In most cases, results are based on fire years of monthly data, measured in U.S. dollars, through August 1996.
Source: IFC (Marber 1998; 187)
Though, the economies of the emerging markets which are believed to be in the early stage of
modernization and industrialization and have been growing robustly; are associated high volatility; they
have yield high returns even more than the developed ones. Nevertheless, many portfolio managers have
operated with the phobia of the high volatility of emerging markets as a negative consideration and that it
erodes the high returns. For example, in 1993, Poland was the best performer among emerging markets,
with a USD return of 970%, but a year later, Poland was among the three worst performers with a USD
return of -43%. The Turkish stock market fell 61% in 1988, rose 502% in 1989, fell 42% in 1991, fell 53%
in 1992, and rose 234% in 1993. Obviously, investing significant amounts in these markets, in the short
run, may be dangerous to the job security (and heart) of a portfolio manager. The low, and even negative,
correlations, however, make these stocks very attractive in the long run.
2.7 Evidences of Economic Growth
Economic growth or development, though they are not technical synonymous, still implies
increase and/or change in the erstwhile condition or state of affairs which is being accounted for by

EMERGING STOCK MARKETS

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