The Determinants of Stock Market Development and Liquidity in Capital Markets

The Determinants of Stock Market Development and Liquidity in Capital Markets

Sarah Newton (University of Kent, UK) and Ingrid O'Connor (University of Cardiff, UK)
Copyright: © 2017 |Pages: 15
DOI: 10.4018/978-1-5225-1900-3.ch010
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Abstract

“At the early stages of its establishment the stock market is a complement rather than substitute for the banking sector. Developing the banking sector can promote stock market development as demonstrated by the experiences of many East Asian countries. However, when stock markets are sufficiently developed they tend to compete with the banking sector as shown by findings.” How does commercial banking impact investment activities in capital markets – and particularly developed capital markets? Is it true then that in certain economies, the banking sector serves as a complementary component of the financial system – up till a stage where it begins to compete with the securities sector? As well as investigating these observations, this chapter is aimed at investigating the validity of Efficient Markets Hypothesis and Efficient Capital Markets Hypothesis in emerging economies – as contrasted with advanced market economies. In so doing, it aims to contribute to the extant literature on stock market liquidity and liquidity in capital markets.
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Introduction

How does commercial banking impact investment activities in capital markets – and particularly developed capital markets? Is it true then that in certain economies, the banking sector serves as a complementary component of the financial system – up till a stage where it begins to compete with the securities sector?

At the early stages of its establishment the stock market is a complement rather than substitute for the banking sector. Developing the banking sector can promote stock market development as demonstrated by the experiences of many East Asian countries. Support services from the banking system contribute significantly to the development of the stock market. However, when stock markets are sufficiently developed they tend to compete with the banking sector as shown by our findings. (Yartey, 2008)

As well as investigating these observations, the chapter will amongst other objectives, aim to contribute to the extant literature on whether capital markets in emerging markets economies, in particular, fully reflect information - hence demonstrating and highlighting the validity of the Efficient Markets Hypothesis (as well as the Efficient Capital Markets Hypothesis.

Other objectives of the chapter are as follows:

  • 1.

    To investigate the extent to which accounting information can be relied upon based on given market values and whether a relationship or pattern can be established in certain jurisdictions based on given operating variables which function in such economies.

  • 2.

    To demonstrate and highlight the validity of the Efficient Markets Hypothesis (as well as the Efficient Capital Markets Hypothesis)

  • 3.

    To demonstrate how accounting information can serve as a useful and vital indicator which will enable investors to interpret financial information in such a way which mitigates information asymmetries between management and investors

  • 4.

    To highlight those areas and factors which influence the quality of accounting information - and which must be addressed by markets if the audit is to achieve its intended aims and functions

  • 5.

    To highlight whether accounting reforms undertaken in investigated jurisdictions actually achieved their desired goals of improving the quality of accounting information and if such reforms were not successful, to propose measures which could address the current issues being faced by such jurisdictions.

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Background And Literature Review

According to PWC, Global Markets Liquidity Study (2015, page 105 of 152):

  • Regulations yet to be implemented, such as FRTB, MiFID II, the US G-SIB surcharge, EU bank structural reform and FTT, if inappropriately calibrated, will have a significant impact on the viability of dealers’ market-making activities and increase transaction costs for capital markets participants.

  • These reforms are likely to have extra-territorial impacts beyond Europe and the US. Although the majority of recently-proposed or implemented reforms originate in Europe and the US, regulators in other parts of the world may follow suit with similar reforms, which will directly affect market participants based in other regions.

Three developments which in PWC’s view “could improve financial markets liquidity in a sub-set of asset classes” are as follows: Firstly, the growth of exchange-traded funds (ETFs) – which they conclude, provides investors with a more tradeable instrument for investment, in the absence of directly investing in the underlying asset, which may not be as liquid.

Second,

  • More widespread uptake of electronic trading which could further reduce transaction costs for market participants by providing additional platforms to match buyers and sellers.

Such platforms, they add, will, in some cases, help reduce the time required to locate buyers and sellers and improve the process of price discovery and they also argue that although electronic trading platforms have seen growth in recent years, they do not replace liquidity provision by dealers - in particular the ability to bear proprietary risk and thereby provide immediacy.

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