Ch 13 International Equity Markets

Chapter 13 International Equity Market Capitalization

Markets • At year-end 2018, total market capitalization of the
• The World’s Equity Markets: A Statistical 80 organized stock exchanges tracked by the World
Perspective Federation of Exchanges (WFE) stood at $74,667b
• Market Structure, Trading Practices, and Costs – Five largest stock exchanges at end of 2018:
• Trading in International Equities • New York Stock Exchange (NYSE)
• Factors Affecting International Equity Returns • NASDAQ
• Japan Exchange Group
• Shanghai Stock Exchange
• Hong Kong Exchanges and Clearing

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Market Liquidity Market Concentration

• Investors would have difficulty diversifying their
• A liquid stock market is one in which investors can
investments in concentrated markets, those
buy and sell stocks quickly at close to the current
dominated by a few large firms
quoted prices
– Concentrated financial markets also represent poor
– A measure of liquidity for a stock market is the turnover access of firms to the stock market
ratio, calculated as the ratio of stock market transactions
– A common measure of stock market concentration is the
over a period of time divided by the size, or market
ratio of the market capitalization of the largest ten
capitalization, of the stock market
companies divided by the total market capitalization
– Generally, the higher the turnover ratio, the more liquid the
• In 2018, the largest ten companies on the Budapest Stock
secondary stock market, indicating ease in trading Exchange accounted for a whopping 95.46% of the total
– In 2018, many national stock exchanges had relatively market capitalization of the stock exchange
high turnover ratios, with close to 40% of the exchanges in • Alternatively, also in 2018, the London Stock Exchange had
excess of 30% turnover on average a much lower concentration ratio of 29.38%
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Market Structure, Trading Practices, Market Structure, Trading Practices,

and Costs and Costs (Continued)
• Secondary equity markets of the world serve two • When conducting a trade in the secondary market,
major purposes: public buyers and sellers are represented by an
1. Provide marketability agent, known as a broker
2. Provide share valuation – Order submitted to broker may be a market or limit order
• Investors who buy shares from the issuing firm in • Market order is executed at the best price available in the
the primary market may not want to hold them market when the order is received, that is, the market price
• Limit order is an order away from the market price that is
indefinitely
held in a limit order book until it can be executed at the
• The secondary market allows those share owners desired price
to reduce holdings of unwanted shares and
purchasers to acquire the stock
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Ch 13 International Equity Markets

Market Structure, Trading Practices, Trading in International Equities

and Costs (Concluded) • During the 1980s, world capital markets began a
• Secondary markets may have different designs that trend toward greater global integration due the
allow for the efficient trading of shares following factors:
– Generally, a secondary market is structured as a dealer 1. Investors began to realize the benefits of
or agency market international portfolio diversification
• In a dealer market, the broker takes the trade through the 2. Major capital markets became more liberalized
dealer, who participates in trades as a principal by buying 3. New computer and communications technology
and selling the security for his own account facilitated efficient and fair securities trading
• In an agency market, the broker takes the client’s order
4. MNCs realized the benefits of sourcing new capital
through the agent, who matches it with another public order
internationally
– Both dealer and agency structures exist in the U.S.

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Cross-Listing of Shares Cross-Listing of Shares (Continued)

• A firm may cross-list shares for many reasons:
• Cross-listing refers to a firm having its equity 1. Provides a means for expanding the investor base for a
shares listed on one or more foreign exchanges, firm’s stock, thus potentially increasing its demand
in addition to the home country stock exchange 2. Establishes name recognition of the company in a new
– Not a new concept, but amount of cross-listing has capital market
exploded in recent years due to increased 3. Brings the firm’s name before more investor and consumer
globalization groups
– MNCs often cross-list their shares, but non-MNCs 4. May be a signal to investors that improved corporate
may choose to cross-list, as well governance is forthcoming (if cross-listing into developed
capital markets with strict securities regulations and
information disclosure requirements)
5. May mitigate the possibility of a hostile takeover of the firm
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Yankee Stock Offerings American Depository Receipts

• Yankee stock offerings are sold directly to U.S. • Foreign stocks can be traded directly on a national
investors by foreign companies stock market, but frequently they are traded in the
– Since the beginning of the 1990s, many foreign companies, form of a depository receipt
Latin America in particular, have listed their stocks on U.S. – Depository receipts (DR) market has grown significantly
exchanges to prime the U.S. equity market for future over the years
Yankee stock offerings
– In 2018 alone, $15b was raised through 49 DR offerings
– Three factors appear to be fueling the sale of Yankee stocks
• An American Depository Receipt (ADR) is a
1. Push for privatization by many Latin American and Eastern
European government-owned companies receipt representing a number of foreign shares
2. Rapid growth in economies of developing countries that remain on deposit with the U.S. depository’s
3. Large demand for new capital by Mexican companies custodian in the issuer’s home market
following approval of NAFTA – First ADRs began trading in 1927
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Ch 13 International Equity Markets

Advantages of ADRs Advantages of ADRs (Continued)

• Investment advantages of ADRs include the • Investment advantages of ADRs include the
following: following:
– ADRs are denominated in dollars, trade on a U.S. – An ADR investment can be sold by trading the
exchange, and can be purchased through the investor’s depository receipt to another investor in the U.S. stock
regular broker market, or the underlying shares can be sold in the local
– Dividends received on the underlying shares are stock market
collected and converted to dollars by the custodian – ADRs frequently represent a multiple of the underlying
– ADR trades clear in 3 business days, as do U.S. equities shares, rather than a one-for-one correspondence, to
– ADR price quotes are in U.S. dollars allow the ADR to trade in a price range customary for
U.S. investors
– ADRs (except Rule 144A issues) are registered
securities that provide for the protection of ownership – ADR holders give instructions to the depository bank as
rights, whereas most underlying stocks are bearer to how to vote the rights associated with the underlying
securities shares
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Empirical Findings on Cross-Listings Empirical Findings on Cross-Listings

and ADRs and ADRs (Continued)
• Several empirical studies document important
findings on cross-listing in general and on ADRs • Jayaraman, Shastri, and Tandon (1993) interpreted their
results as evidence that an ADR listing provides the
in particular issuing firm with another market from which to source
• Listed below are a few examples: new equity capital
– Ammer et al. (2012) found that the single most • Results of Berkman and Nguyen (2010) indicate that
important determinant of the amount of U.S. cross-listed firms from countries with poor corporate
investment a foreign firm receives is whether the firm governance and/or weak accounting standards gain from
cross-lists on a U.S. exchange improvements in domestic liquidity in the first two years
– Sarkissian and Schill (2016) established that cross- after cross-listing but tend to diminish later
listing occurs in waves at the host market, home
market, and industry levels
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Factors Affecting International Equity Macroeconomic Factors

Returns • Two studies have tested the influence of various
• Which factors influence equity returns? macroeconomic variables on stock returns
1. Solnik (1984) found that international monetary
– Macroeconomic factors variables had only weak influence on equity returns
– Exchange rates in comparison to domestic variables
– Industrial structure 2. Asprem (1989) found that changes in industrial
production, employment, and imports, the level of
interest rates, and an inflation measure explained
only a small portion of the variability of equity returns
for ten European countries, but that substantially
more of the variation was explained by an
international market index
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Ch 13 International Equity Markets

Exchange Rates Industrial Structure

• Adler and Simon (1986) • Studies examining the influence of industrial
– Found changes in exchange rates generally structure on foreign equity returns are
explained a larger portion of the variability of foreign inconclusive
bond indexes than foreign equity indexes
• Eun and Resnick (1988)
– Found that the cross-correlations among major stock
markets and exchange markets are relatively low, but
positive
• Gupta and Finnerty (1992)
– Concluded that exchange risk is generally not priced
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