non-fundamentals and stock market: new evidence moshfique uddin (lubs) anup chowdhury (tyms) keith...
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Non-fundamentals and Stock Market: New Evidence
Moshfique Uddin (LUBS)Anup Chowdhury (TYMS)Keith Anderson (TYMS)
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Introduction and Motivation
• There is growing evidence that the standard valuation model has failed to capture the stock market movements.
• Therefore, it is important to identify and evaluate drivers of volatility other than conventional dividends and earnings, such as, national elections, political uncertainty, government policy, regulatory changes, along with monetary and fiscal policies.
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Introduction and Motivation
• The aim of this paper is to provide new evidences by analysing the reaction of an emerging stock market to non-fundamental factors. Particularly, in a first step, we investigate whether stock prices behaviour of this market changes over time or switches over states with respect to timing of monetary policy, fiscal policy, political events, national election, changes in government policies and changes in capital markets regulations.
• In second step, we extend our analysis to provide firm-level evidence related to this interdependence. We examine whether any of the macro and non-macroeconomic news has specific effect on portfolios with different characteristics, i.e. size, dividend yield and sectors.
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Introduction and Motivation
• The stock market i.e. Dhaka Stock Exchange (DSE) is one of the fastest growing equity markets of this region and named as one of the best performing markets in the world (see The Economist, 2011; Rintoul, 2012).
• The economy and the stock market in Bangladesh have some interesting characteristics, which are distinctly different than most other developed and emerging economies.
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Introduction and Motivation
• From 1990-2011, it has had a system of interim non-political governments (commonly known as Caretaker Government (CG)) between politically elected governments. The CG has presented three national budgets and conducted four national elections.
• The political government of this country is very powerful and intervene into the equity market, such as to increase the liquidity government has allowed the black money (undisclosed) in the stock market.
• Bangladesh is a commonplace of political uncertainty. Since 1990 there have been more than 1100 days (equal to about 4 working years) of nation-wide strike (commonly known as hartal) called by political parties till 2012 (UNDP, 2005).
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Introduction and Motivation• As a Muslim country, Bangladesh has stocks of different sets of
industries or firms listed other than conventional operation, e.g. banks with Islamic banking norms. Chau et al., (2014) identify that conventional and Islamic financial market indices react heterogeneously to the political turmoil and the volatility of Islamic indices significantly increases during the period of political unrests.
• More than 90 percent equity investors are individuals in Dhaka Stock Exchange (DSE), who usually have less capacity to diversify their portfolios may be due to small scale of investment and lack of knowledge about the capital market. Hence, they are very sensitive to any shocks or surprise, particularly to any form of negative information.
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Monetary Policy shocks and the capital market
• Equity market performance not only responds to monetary policy decisions and affect the economy but also provide feedback effect to the central bank regarding the private sector’s expectations about the future course of key macroeconomic variables (Mishkin, 2001).
• Monetary policy can influence the asset prices (e.g. stock market) via different channels, such as via changes in cost of capital, via subsequent changes in the investment opportunity set faced by firms, via other mechanisms, such as exchange rate and transfer of funds between stock and bond markets and adjusting investors’ expectation (see Tobin, 1969; Mishkin, 2001, Bernanke and Kuttner, 2005; Chatziantoniou et al., 2013).
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Fiscal Policy shocks on equity markets
• According to Keynesian approach fiscal policy can support aggregate demand, boosting the economy and thus positively contributing to the financial market.
• They argue that contractionary and expansionary fiscal policy shocks related to government spending, deficit financing, public sector investment and tax policy could directly influence equity markets.
• Darrat (1988, 1990) in his two papers empirically tested stock market efficiency with respect to both monetary and fiscal policy variables. He asserts that fiscal policy stance plays a significant role in determining stock returns even when the path through interest rates is excluded. In a separate study, Darrat and Brocato (1994) claim that the Federal budget deficit exerts a significant lagged impact on current US stock returns.
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Political and other non-macroeconomic shocks on stock markets
• Empirical evidence strongly suggests that the stock market is not only influenced by monetary and fiscal policies but also by other macro and non-macroeconomic factors, such as, political uncertainty, national elections, changes in rules and regulations related to capital markets etc.
• Wang and Theobald (2008) examine the regime-switching behaviour of equity return volatility of six East Asian markets following the introduction of liberalization policies in the mid to late 1980s and early 1990s. Their model detects two or three volatility states and results suggest that the switching between regimes is associated with international and country-specific events, such as – Asian financial crisis, political instability, failed military coup attempts, Gulf-war and oil price shocks.
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Political and other non-macroeconomic shocks on stock markets
• Bialkowshi et al. (2008) investigate stock market volatility around national election from 27 OECD countries. They document that the index return variance become double during the week around an election and stock markets can become very unsettled during the period of important political changes. Mei and Guo (2004) also observe increased market volatility during political election and transition periods.
• Bengtsson et al. (2014) investigate a series of enforcement actions taken by the Securities and Exchange Commission (SEC) of the US and their results indicate enforcement actions influence the public equity investors and thus stock prices.
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Firm level evidences of economic shocks
• It is documented in earlier literature that firms are not homogeneously affected by news. For example, Wasserfallen (1989) explains that the effect of macroeconomic events may also depend on characteristics specific to a firm or an industry, such as, the amount of international trade, inflation, changes in money supply etc.
• In one of the early study, Gertler and Gilchrist (1994) suggest that monetary policy should have disproportionate impact on borrowers with limited access to capital markets, everything else equal. They argue that small firms are strongly affected by monetary policy shocks since they are likely to face more constrained in financial markets for borrowing.
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Firm level evidences of economic shocks
• Ehrmann and Fratzscher (2004) explain that the effect of monetary policy on stock market returns is likely to differ across industries for various reasons; firms in cyclical industries, capital-intensive industries, and industries that are relatively open to trade are affected more strongly.
• Dedola and Lippi’s (2005) use 21 manufacturing sectors from five OECD countries (i.e. France, Germany, Italy, the UK and the US). Their analysis further reveals that the impact of monetary policy is stronger in industries that produce durable goods, have greater financing requirements, lower borrowing capacity and small size.
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Data and Analysis
• Where, is the daily return of the DSE all-share price index, , , and are the daily return of local, regional and world equity indices over the sample period. The autoregressive terms , are included in the return equation to account for the problem of autocorrelation potentially induced by nonsynchronous trading, which is particularly severe in emerging markets given their low level of liquidity (see Lee and Rui, 2001). is day-of-the-week dummy for Sunday, as Chowdhury, Uddin and Anderson (2013) have identified a Sunday effect for the DSE all-share price index. We use the residual }as our new filtered return series for this analysis and renamed it as .
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Data and Analysis
• We use Markov Regime Switching GARCH (MS-GARCH) model of Haas et al., (2004) to check the robustness of structural breaks and interdependence between economic information and stock markets.
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Data and Analysis• In order to discuss the influence of macro and non-macro
information on daily returns and variance of firms based on size, dividend and sectors, the empirical model assumes returns ( follow the following process, similar to equation (ii), (iii) and (iv)
• , (xiii)• (xiv)• (xv)• Where, is the filtered return of each of the value-weighted indices
for firm characteristics; and are the dummy variables for macro and non-macro variables in mean and volatility equations respectively. The significance of and implies the reaction of each portfolio to each of the macroeconomic and non-macro information around the structural breaks or regimes switching.
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Data and Analysis
• For detecting the structural breaks and regime shifts we use daily index of DSE (Dhaka Stock Exchange) all-share price from Datastream over a period from 1 January, 1990 till 31 December, 2012.
• The daily market capitalization, dividend yield and market price for each of the 265 firms are also collected from Datastream. However, firm level data is only available in Datastream from 1 January 2000 till 31 December 2012; therefore we take this dataset which includes more than one million observations.
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Data and Analysis• We divide all the 265 firms into four sectors, namely,
manufacturing, service, financial and miscellaneous and the value weighted index for each of the sector is calculated based on the algorithm given in the Dhaka Stock Exchange.
• Finally, we also consider international benchmark indices to proxy for the world, regional and local influences, those indices are – MSCI (i.e. Morgan Stanley Capital International) World, MSCI Emerging Market, MSCI Emerging Market Asia and Industry specific (i.e. Financial Sector, Manufacturing and Service) indices from MSCI World and MSCI Emerging Market. Macroeconomic and non-macroeconomic events, which are considered over the sample period for this study, are hand collected.
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Main Findings
• Results indicate that DSE is highly sensitive to political uncertainty, electoral system, money growth policy and government debt policy.
• Interestingly, market has shown strong confidence and less volatility during the period of caretaker government system. This finding is relatively novel because prior research in emerging markets, such as Diamonte et al. (1996), Bilson et al. (2002) and Chau et al. (2014) do not empirically examine the stock market response to electoral system.
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Main Findings
• This paper provides new evidence on the interdependence between firm characteristics (i.e. size, dividend yield and industry) and non-macroeconomic factors (i.e. political risk, national election, electoral system and regulatory changes), where the empirical substantiations are limited, particularly from emerging market it is rare.
• Using modified GJR-GARCH model we find top and bottom 20% firms are sensitive to any information; smaller firms are significantly influenced by the changes in monetary policy variables; political uncertainty of 2007 has greater impact on the market; financial and manufacturing sectors are more sensitive to both macro and non-macro news.
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Main Findings
• the impact of lagged regional and world market index (i.e. to ) is not found significant for most of the portfolios.
• However, local and regional factors are reported significant only for DSE itself, top 10% firms, and financial industry. This result, therefore, support the argument that market exhibit strong home bias.
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Main Findings
• Estimated dates for structural changes in DSE conditional variance are 22 November 1996, 25 July 2000, 21 September 2004, 9 January 2007 and 15 September 2010. The structural breaks dates for equity returns, which are on 21 November 1996 and on 12 April, 2005 respectively.
• We link the breakpoints with the daily price index of DSE over the sample period 1990-2012. It shows that the break dates coincide with the major price fluctuations of this stock market, such as two big slumps those happened in DSE in 1996 and 2010 and other two minor crashes those happened in 2005 and 2008.
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Main Findings
• Financial sector is mostly affected by the information under this study; which is probably due to their strong involvement with the capital market and methods of their business
• Changes in exchange rate regime (i.e. from pegged to floating system in 2003) do not change the price behaviour significantly.
• The impact of CRR is stronger to control the excess money supply in Bangladesh. Particularly, the effect of raising the CRR has a relatively higher impact on investment, such as in capital market.
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Main Findings
• The government of Bangladesh allows the black money into stock market to satisfy the investors, which initially increases the demand of stocks and the price but, unfortunately, that growth does not sustain in the long run.
• Government pressure on the central bank and SEC to stabilize the market after plunge of 2010 did not work
• Unfortunately, in Bangladesh, remittance only raises the size of the market but not the efficiency.
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Many thanks for your time.
For any further informationPlease contact
Moshfique UddinLeeds University Business School, UK