Market Liquidity and Stock Size Premia in Emerging Financial Markets: The Implications for Foreign Investment
University of Sussex
Bournemouth University; University of Stellbosch
Bruce Allen Hearn
University of Sussex
July 20, 2008
International Business Review, Vol. 19, No. 5, 2010
Equity markets are increasingly seen as important sources of investment funds in many emerging economies, both in Africa and elsewhere. Furthermore, many countries perceive the development of such markets as a means to facilitate both foreign equity portfolio investment and foreign direct investment (FDI) through the acquisition of shareholdings in domestic companies, and thus supplement the low levels of funding from domestic savings. But many emerging stock markets exhibit substantial risk premia, which both push up the cost of equity for listed domestic firms and deter potential foreign investors. This paper estimates the cost of equity in four major African markets: South Africa, Kenya, Egypt and Morocco. These collectively represent the largest and most developed equity markets in Africa and also act as hub markets in their respective regions. London is also included as a link between the emerging and developed financial market. The Fama and French (1993) three-factor model Capital Asset Pricing Model is augmented to take account of company size and illiquidity factors that feature in African financial markets. Results show that the premia associated with size are more prevalent than with liquidity although both are highly significant in both valuation and cost of equity estimates. The evidence suggests that the lowest cost of equity is achieved in the two major international markets of London and Johannesburg, while the less-advanced North African markets of Morocco and Egypt have higher costs of equity. The small developing market of Kenya has the highest cost of equity, although the costs associated with the main market are less than one-third of that faced by companies in the fledgling Alternative Investment Market.
Number of Pages in PDF File: 29
Keywords: Africa, Capital Asset Pricing Model, Liquidity, Emerging Financial Markets
JEL Classification: G12, G15, O16Accepted Paper Series
Date posted: July 23, 2008 ; Last revised: January 12, 2011
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