Finance: Research, Policy and Anecdotes

Nascent stock exchanges

Lots of research has explored the development and efficiency of equity markets in emerging and developing economies. Few studies, however, have focused on the nascent markets – the recently established stock exchanges across the developing world.  At a time, when a third of countries across the globe does not have a stock exchange yet, but many countries still consider establishing ones, there are obvious questions for policy makers: what are the success factors for a successful market, what institutions and policies are needed.  In a recent working paper with  José Albuquerque de Sousa, Peter van Bergeijk, and Mathijs van Dijk we explore these questions.  

Specifically, we use an array of different methodologies to gauge the factors associated with the variation in success and failures of newly established stock markets across a sample of 59 developing countries that have opened a stock exchange since 1975. Herewith our main findings.  Paper is here and Vox column with nice graphs here

  • We find a clear distinction between two clusters of nascent markets (indicated in different colors): a cluster of markets with a relatively high number of listings, large market capitalization, and high turnover, and a cluster of markets with relatively low values for each of these measures. China and Swaziland are the two extremes along the three dimensions of success. China has the most successful stock market, with an average of 1,477 listed companies (Shanghai and Shenzhen combined), market cap representing 77% of GDP, and turnover of 130% over the period of 16-20 years. Swaziland is the least successful market, with an average of 6 listed companies, market cap representing 8% of GDP, and almost no trading activity (turnover is close to 0%) in the fourth 5-year interval after establishment.
  • A minimum number of listings and turnover in the first five years are necessary conditions for success along both of these dimensions after 20 years. Stock markets that start out with few listings and low trading activity fail to attract a considerable number of listings and to spur adequate trading activity in a later stage, and run the risk of quickly becoming dormant.EndFragment On the other hand, there is little evidence that the initial market cap is a necessary condition for long-term success.

  • The long-term success of nascent stock markets is mostly determined by their early success, and by the environment in which they are established. Stock markets’ early success, as well as country characteristics at the moment of establishment, explain more than 60% of the variation in success 15 years later.

  • The size of the banking sector at the moment of stock market formation is the most reliable predictor of its success. A 1% higher private credit provided by the banking sector and other financial institutions is associated with a 1% higher number of listed companies, a 0.4% higher market capitalization (% GDP) and a 0.7% higher turnover ratio 15 years later.

  • Panel regressions point to the development of national savings over the life of the stock market as the most important predictor of stock market success. 

What do these findings imply for countries assessing the policy option of establishing a stock exchange? Stock markets thrive when they are established at the right stage of a country’s development. More than specific policies, the development of the banking system and the necessary scale seem driving factors for success.