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Post Crisis Investment Issues in Emerging Markets

Post Crisis Investment Issues in Emerging Markets

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Published by vivekagrawal07

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Published by: vivekagrawal07 on May 31, 2011
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11/04/2014

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Post Crisis Investment Issues in emerging marketsProblem StatementEmerging markets due to their fundamental nature of being in the state of constant evolution, possesssome serious issues for global investors which have come up more prominently after the financial crisisof 2008, and financial frauds from companies like satyam, which once received award for best corporategovernance practices. Here we try to analyses that, although being emerging in nature, these developingmarkets provide great investment opportunities and better returns in the long term, for which investorsmust be accepted to take higher risks, as the basic principle of corporate finance goes higher risk higherreturns. Moreover world has seen financial crises happening in one of the most sophisticatedeconomies in the world, which means no economy is immune from financial turmoil.Objective of studyEmerging markets have generated considerable interest among investors and academics. Although theirreturns are increasingly converging to those of the developed world because of integration andliberalization, they still provide benefits to a global portfolio, particularly in post 2008 financial crisisworld.HypothesisThe basic hypothesis of this research is that although emerging markets have higher risks, they alsoprovide higher returns. Moreover, there is rising signs that emerging markets are continuouslyintegrating with global markets, which means that this era provides a golden opportunity for goodreturns.Body of researchBecause of their higher economic growth and potentially higher returns, emerging markets havereceived increasing attention from investors in the developed world. They are also said to providediversification benefits for U.S. investors because of their low correlations with U.S. assets. It is welldocumented that the benefits of international diversification within developed markets have declinedover time because of increasing correlations. Emerging markets, however, offer both lower correlationsand an expanded number of markets to invest in. although their performance is converging to that of developed markets, emerging markets are still more distinct from one another than developed marketsare and still provide diversification benefits to the global investor.Also increasing their exposure is the ability of emerging markets to provide benefits to the developedworld on a global macroeconomic level.The continued growth of emerging markets meansThat the U.S. economy is more diversified across countries because it does not depend solely ondeveloped markets.If stronger economic growth in emerging markets implies higher stock returns, thenthe developed world should allocate more capital to them. This increased investment would strengthenemerging market currency values and market capitalizations. As a result, their representation in a well-
 
diversified global portfolio and their importance in the global economy would increase in thefuture.Despite the attractiveness of emerging markets, investing in them has many issues andassociated risks that are not present in the developed world. In the past several years, a great deal of research has been conducted on emerging market issues. The most prominent areas are thoseconcerning non-normality and synchronicity in returns, corporate governance, contagion, changes fromintegration and liberalization, return factors, institutional investor and analyst performance, andcurrency issues.Non-normality and Synchronicity in ReturnsIt is generally accepted that emerging market stock returns are not normally distributed. Extremereturns are more frequent than under a normal distribution, which results in a fat-tailed (leptokurtic)distribution. Both large positive (positive skewness) and large negative (negative skewness) returns havebeen found in various emerging markets. These return distributions violate the normality assumption inthe meanvariance analysis framework commonly used in portfolio management.Positively skewed returns in emerging markets are a result of risk sharing and poor corporategovernance. Many emerging markets contain families of companies, and a family will not let anindividual member experience financial distress. Companies with poor governance usually have poorinformation disclosure and often will hide bad news or release it only slowly. The result is that positivelyskewed returns will be more common than negatively skewed returns. The authors document thatemerging market returns are positively skewed when ownership is concentrated, when a company ispart of a family, and when governance is poor.Another explanation for high R2s in emerging markets is the type of information analysts produce. If emerging market analysts do not produce much company-specific information because property rightsare weak, then the information they do produce will be predominantly market wide. Essentially, analystswill not have an incentive to produce company-specific information if property rights are weak becausethe production of such information will not lead to superior performance.Also, greater analyst coverage increases the synchronicity of stock prices in emerging markets, which isconsistent with analysts producing primarily market wide information. Furthermore, the returns of stocks with high analyst coverage lead those with low coverage, which implies that the prices of companies with high analyst coverage reflect market wide information more quickly. Lastly, theaggregate earnings forecasts for high-coverage stocks affect the returns of those with less analystcoverage. The idea that analysts produce market wide information for emerging market companies isconfirmed by examining companies that have cross-listed their stocks on a foreignexchange.theinformativeness of a companys stock price using the variation in the company-specificcomponent.The variation in the proportion of a companys stock return not caused by market movements measuresinformativeness, with lower volatility indicating less informativeness. For emerging market companiesthat arecross-listed on a U.S. exchange, the informativeness of their stock price is lower than that of non-listed companies. The authors attribute this result to increased analyst coverage for cross-listed
 
companies. If analysts produce primarily marketwide information for emerging market stocks, thenprices should be more closely associated with market movements, which is in contrast to developedmarket companies, where cross-listing increases informativeness. The increase in informativeness ishighest for companies from countries where investor protection is high.In sum, emerging market returnsare nonnormal, which has significant implications for investors. Positively and negatively skewed returnsare a result of company ownership, corporate governance, and opaqueness. Return synchronicity is aresult of opaqueness and the market wide information that analysts produce for emerging marketcompanies.Corporate governanceEmerging countries typically have weak investor protections. Although corporate governance practicesare improving, several examples of the weaknesses found in emerging countries are:
y
 
Management uses its control for perquisite consumption.
y
 
Company shares are owned by another company that exerts control.
y
 
Creditor rights are often strong to the detriment of shareholders.One method of determining the value of better shareholder protection is to examine the gains toacquirers of emerging market companies. In the United States, it has been extensively documented that,on average, acquirers pay too much for target companies and that gains accrue only to targetshareholders in a merger. In the case of emerging market targets, however, discover that acquirershareholders often benefit from an acquisition. The gains are substantial, averaging about 10 percent of target value, and are larger when there is weaker shareholder protection in the emerging market targetcountry. There are no gains when the acquirer buys a minority stake. The gains are smaller when boththe target and acquirer are emerging market companies. These results are consistent with acquirersgaining by instituting better corporate governance practices at the target. These protections forshareholders are especially important when intangible assets, such as patents, are involved. Likewise,that target shareholder excess returns increase when an acquirer is located in a country with bettershareholder protection and accounting standards. The acquisitions studied were those for control,where the target companies adopt the more stringent practices of the acquirer. Also, improvements incorporate governance of emerging market companies are accompanied by increases in company value,as measured by Tobins q and the market-to-book ratio. Additionally, improvements in country risk arerelated to improved governance at the company level.In summary, improvements in corporate governance of emerging market companies increaseshareholder wealth, company valuation, and investor interest. Corporate governance is related tocountry risk and legal origin.ContagionAlthough most studies find that emerging markets have return and diversification benefits over thelonger term, there have been shorter periods when emerging markets have decreased the return andincreased the risk of a global portfolio.These periods to contagious emerging market crises, where

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