Foreign Speculators and Emerging Equity Markets

Abstract

A number of countries have delayed the opening of their capital markets to international investment because of reservations about the impact of foreign speculators on both expected returns and market volatility. We propose a cross-sectional time-series model that attempts to assess the impact of market liberalizations, in the form of the offering of depositary receipts, country funds and other financial instruments, in an extranational market, on the cost of capital and market volatility in emerging equity markets. We also examine the impact of capital market liberalizations on the correlation of emerging equity market returns and the world market return. Our empirical approach is designed to control for other economic events which might confound the impact of foreign speculators on local equity markets. Whatever the empirical specification, the cost of capital always decreases after a capital market liberalization with the effect varying between 5 and 90 basis points depending on the specification. There is little impact on volatility. While correlation with world markets increases after liberalizations, it is unlikely that this higher correlation will impact global investors looking to diversify their international portfolios.

Keywords: Equity Market Liberalization, Cost of Capital, Investment Growth, Economic Growth, Liberalization and Risk, Country Correlations, Country Betas, Country Volatility

JEL Classification: F30, F36, G15, G12