Foreign Speculators and Emerging Equity Markets

Source: Bekaert, G. & Harvey, C. R. (2000). Journal of Finance 55(2), 565–613.

TL;DR

A cross-sectional time-series study of what happens when emerging equity markets liberalize (open

to foreign investors). Across a wide range of specifications, **the cost of capital always falls after

liberalization — by 5 to 75 basis points**. World-market correlation tends to rise, while the effect

on local volatility is small. Liberalization makes capital cheaper without dramatically destabilizing

prices. Sample: 20 emerging markets (IFC data).

The move from a segmented market (equities priced by local risk) toward an integrated one

(priced by global, world-market risk) should lower required returns, because global investors bid up

prices and share risk more efficiently. The authors exploit the timing of liberalization reforms as a

natural experiment, controlling for confounding macroeconomic events, to measure the asset-pricing

consequences along four dimensions: cost of capital, volatility, world beta, and world correlation.

Method: Liberalizations are dated using (1) official regulatory changes, (2) the introduction of

ADRs / depositary receipts and country funds, and (3) structural breaks in equity capital flows.

Dividend yields proxy the cost of capital; conditional volatility, beta, and correlation are modeled.

Cost of capital: decreases after liberalization in every specification, with the estimated

effect varying between 5 and 75 basis points (consistent with improved risk sharing / lower

required returns).

Correlation with the world market rises post-liberalization, which dampens (but does not

eliminate) the cost-of-capital benefit.

Volatility: the effect is small — little support for the "foreign speculators destabilize

markets" excess-volatility argument.

Integration is gradual and partial, not a one-time on/off switch.

A foundational empirical study of market integration vs segmentation and the pricing of global vs

local risk — central to international asset pricing, emerging-market investing, and the policy debate

over capital-account opening. It complements Henry (2000), who finds positive abnormal returns around

liberalizations in 12 emerging markets.

Liberalization dates are imprecise and often coincide with other reforms (endogeneity), which the

controls can only partly address.

Cost-of-capital inference via dividend yields is indirect.

Emerging-market data of the period are noisy, illiquid, and have short histories.

Bekaert, G. & Harvey, C. (2000) — Foreign Speculators and Emerging Equity Markets — Journal of Finance

Bekaert, G. & Harvey, C. (1995) — Time-Varying World Market Integration — Journal of Finance

Henry, P. B. (2000) — Stock Market Liberalization, Economic Reform, and Emerging Market Equity Prices — Journal of Finance

Provenance: verified/generated from the paper's full text.