Emerging Markets Research Now and in the Future

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Emerging Markets Research Now and in the Future
Valuation in Emerging Markets Batten Institute
and AIMR Darden at University of Virginia May
28-30, 2002

• Campbell R. Harvey
• Duke University and NBER

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Emerging Markets Research
Materials in my presentation are largely drawn
from my past and on-going collaborations with
Geert Bekaert at Columbia University.
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Emerging Markets Research Program
Bekaert WBER95 Investment Barriers
Harvey RFS95 WBER95 Predictable Risk
Bekaert and Harvey JFE97 Emerging Market
Volatility
Bekaert and Harvey JF95 Time-Varying Integration
Bekaert, Erb, Harvey Viskanta BOOK, JPM97
Behavior of Returns and Asset Allocation
Bekaert and Harvey NBER98 Capital Flows
Bekaert and Harvey JF2000 Foreign Speculators
Bekaert, Harvey Lumsdaine JFE2002
Dating Integration
Bekaert, Harvey Lumsdaine JIMF2002
Dynamics of Capital Flows
Bekaert, Harvey Lundblad WP2002
Liberalization and Growth
Bekaert, Harvey Lundblad JDE2002 Finance and
Growth Econometrics
Bekaert, Harvey Lundblad WP2002
Liberalization and Growth Volatility
Bekaert, Harvey Lundblad WP2002 Emerging Mrt
Liquidity Expected Returns
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Emerging Markets Research

• My first look at the data
• Data through June 1992
• Published in RFS 1995
• What has happened since?

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Average Annual Geometric Returns
Through June 1992
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Average Annual Geometric Returns Through
June 1992 What Happened After?
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Average Annualized Standard Deviation
Through June 1992
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Average Annualized Standard Deviation Through
June 1992 What Happened After?
Data through April 2002
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Correlation with World Through June 1992
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Correlation with World Through
June 1992 What Happened After?
Data through April 2002
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Beta with World Through June 1992
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Beta with World Through
June 1992 What Happened After?
Data through April 2002
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Evolution of World Correlation
Five-Year Rolling Window 20 Countries
IFC Composite
Average of 20 Emerging Countries
Data through April 2002.
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Evolution of World Beta Risk
Five-Year Rolling Window 20 Countries
IFC Composite
Average of 20 Emerging Countries
Data through April 2002.
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Emerging Markets Research

• Why is the picture different?
• Financial liberalizations

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Asset Prices and Market Integration
Prices
Segmented
Integrated
PI
PS
Return to Integration
Time
High Expected Announcement
Implementation Low Expected Returns
of Liberalization
Returns
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Average Annual Geometric Returns Pre and
Post Bekaert-Harvey Official Liberalization Dates
Data through April 2002. There are no
pre-liberalization data for Indonesia.
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Average Annualized Standard Deviation Pre
and Post Bekaert-Harvey Official Liberalization
Dates
Data through April 2002. There are no
pre-liberalization data for Indonesia.
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Correlation with World Pre
and Post Bekaert-Harvey Official Liberalization
Dates
Data through April 2002. There are no
pre-liberalization data for Indonesia.
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Beta with World Pre and
Post Bekaert-Harvey Official Liberalization Dates
Data through April 2002. There are no
pre-liberalization data for Indonesia.
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Emerging Markets Research

• Implications
• Lower cost of capital
• More investment, employment
• More economic growth
• Current research with Geert Bekaert and Chris
  Lundblad explores the relation between equity
  market liberalization and the real economy

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Emerging Markets Research
Geert Bekaert, Campbell Harvey and Chris
Lundblad, Does Financial Liberalization Spur
Growth? Working paper 2002
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Financial Liberalization
Relaxing Fin Constraints
Growth Opportunities
Cost of Capital
Financial Development
Investment
Efficiency of Investment
Growth
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Financial Liberalization and Growth

• Controversial exercise
• Liberalization implies consumption booms and
  inefficient investment (crisis literature)
• Liberalization may lead to reduced savings
  (endogenous growth literature)
• Liberalization may lead to hot speculative
  capital and induce capital flight (Stiglitz
  others)

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Financial Liberalization and Growth

• What we already know (too many references to
  list!)
• Financial/banking development associated with
  higher growth
• Cost of capital decreases
• Investment increases

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Financial Liberalization and Growth

• Outline
• 1. Did liberalization spur growth?
• Large panel of data
• Cross-sectional growth regression with temporal
  dimension
• 2. How did liberalization spur growth?
• 3. Accounting for the liberalization effect
• Is is macro-economic reforms?
• Is it financial development?
• Other simultaneity biases?
• 4. Conclusions

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Financial Liberalization and Growth

• Caveats
• Not much guidance from theory.
• As a result, it is important to conduct extensive
  robustness experiments

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Financial Liberalization and Growth

• Econometric Framework

where yi,tk,k is real per capita GDP growth
between t and tk Qi,1980 is initial GDP, Xi,t
represents control variables Libi,t is a
Liberalization indicator variable
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Financial Liberalization and Growth

• Econometric Framework

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Financial Liberalization and Growth

• Econometric Framework

ST is the variance covariance matrix of the
sample orthogonality conditions
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Financial Liberalization and Growth

• Key issues
• Temporal dimension
• Different weighting matrices
• Liberalization variable
• Choice of k
• Endogeneity of the liberalization decision

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Financial Liberalization and Growth

• Data Four samples determined by availability of
  data
• Sample I 95 countries
• Sample II 75 countries
• macroeconomic and demographic data

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Financial Liberalization and Growth

• Data Four samples determined by availability of
  data
• Sample III 50 countries
• Sample IV 28 countries
• add financial development indicators
• As data requirements become more stringent, the
  variance of GDP levels across countries in the
  sample decreases.

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Financial Liberalization and Growth

• Liberalization dates
• Use Bekaert and Harvey (JF 2000) official
  liberalization dates
• These dates are based on a detailed chronology of
  important regulatory events
• Augmented with IFC frontier markets and three
  developed markets, Spain, New Zealand and Japan

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Financial Liberalization and Growth

• Liberalization dates
• Robustness of our results checked by examining
  Bekaert and Harvey (2000)s First Sign dates
• These dates based on the earliest date of
  official liberalization, first ADR and first
  closed-end fund
• Example Thailand
• Official 198709
• First Sign 198507

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Financial Liberalization and Growth

• Liberalization dates
• Capturing intensity or comprehensiveness of
  the liberalization
• Ratio of IFC investable market cap to global
  stocks (Bekaert (1995) and Edison and Warnock
  (2001))
• U.S. holdings of domestic market capitalization
• Is it just a proxy for capital account openness?
  See Rodrik-Edwards debate

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Financial Liberalization and Growth

• Are the dates exogenous?
• Counter examples
• Spain in the EU
• Some countries cannot liberalize their financial
  markets

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Financial Liberalization and Growth

• Findings so far
• We document a liberalization effect on growth
  with certain "standard control variables"

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Financial Liberalization and Growth

• Findings so far
• The liberalization effect is robust to
• different definitions of liberalization dates
• to business cycle or interest rate controls
• allowing for intensity of liberalization
• ...and independent of capital account
  liberalization

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Financial Liberalization and Growth

• Channels of increased growth
• Both
• increased investment, partially through a cost of
  capital effect and
• increased productivity (which is different from
  the financial development literature)

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Financial Liberalization and Growth

• On the mechanism ...
• Liberalization does not lead to consumption binge
  
• investment increases
• trade balance decreases

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Financial Liberalization and Growth

• On the mechanism ...
• Investment increases - but you need a minimum
  country quality level to see effect
• decreased cost of capital associated with more
  investment

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Financial Liberalization and Growth

• On the mechanism ...
• Productivity increases
• and this is not just a banking development effect
  

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Financial Liberalization and Growth

• Accounting for the liberalization effect
• We investigate whether part of the effect can be
  ascribed to
• macroeconomic reforms
• financial development
• other regulatory reforms

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Financial Liberalization and Growth

• Accounting for the liberalization effect
• Macroeconomic reforms ...
• Liberalization not spuriously reflecting
  macroeconomic reforms
• we control for trade openness, inflation, black
  market premiums, and government deficits

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Financial Liberalization and Growth

• Accounting for the liberalization effect
• Financial development ...
• Degree of banking and equity market development
  is important but independent boost from
  liberalization
• we examine the size of private credit, equity
  market activity, and equity market size

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Financial Liberalization and Growth

• Accounting for the liberalization effect
• Other regulatory reforms ...
• The financial liberalization/growth effect is not
  a post-banking crisis effect
• The enforcement of law and institutions are
  important

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization spurs growth by 1 per
  annum over the five years
• Survives a battery of robustness experiments
• We understand better the channels whereby growth
  impacted by financial liberalization
• Liberalization effect not spuriously accounted
  for by a host of other events such as
  macro-economic reforms

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization has a very important
  economic effect

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization has a very important
  economic effect
• Consider economic impact of improvements plus a
  equity market liberalization

Liberalization
Total Growth 3.02
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Financial Liberalization and Growth

• On going research
• What about growth volatility?
• Geert Bekaert, Campbell Harvey and Chris
  Lundblad, Growth Volatility and Equity Market
  Liberalization, Working paper 2002

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