What is portfolio investment in international trade?

4 Conclusions

In this chapter we have discussed the effect of changes in remittances on the changes on real effective exchange rates, and we have concentrated our efforts on showing that remittances are a more stable form of capital entering a local economy than other capital sources [FDI and FPI] and that, as such, they play a very significant role when other sources of funds are exiting the economies. This is particularly relevant for those interested on investing in frontier markets.

We have mentioned the economic and social reasons why remittances behave differently than other forms of capital: remittances enter the economy as an income transfer from one household abroad to another one in the home country. The transfer of funds can be used for consumption, savings, or investment purposes, and the funds usually do not leave the economy. Moreover, senders [immigrants] tend to send a steady flow of remittances and may even increase the amount sent in times of economic downturns in the home country. The familial relations underpinning the flow of remittances make them unique in their reliability as a stable transfer of funds. Motives to send remittances hinge on host country economic conditions that may result in a rise in migrant incomes as well as altruistic and insurance motives to help maintain family ties in the home country. Therefore, factors that may lead to diminishing foreign investment flows do not necessarily have the same impact on remittance flows.

In comparison to other types of capital inflows, remittances have been found to contribute to the stabilization of current account positions, while reducing the volatility of capital flows and output volatility in the home country. This impact on the domestic economy provides improved debt sustainability and better creditworthiness in developing countries, as well as a vital source of foreign currency when other flows dry up.

Our results show that if remittances are a constant inflow of funds into local economies, they play a significant role against depreciation pressures when other forms of capital [FDI and FPI] are exiting the economy, and, as such, remittances have an important effect in analyzing and understanding exchange rate dynamics. These results are consistent across regions and countries and across high and low remittance receiver countries. However, the impact of the changes in remittances is significantly stronger on those high remittance economies.

19.5.2.3 Financial Openness

There are mechanisms other than trade through which economic globalization can accelerate earnings and income inequality. One such mechanism is cross-border movement of capital, a factor that is overlooked in the basic trade model, which assumes that labor and capital are mobile within a country but not internationally. Factors such as deregulation, privatization and advances in technology all contributed to the rapid growth of capital movement, in particular FDI, over the past decades. If the utilization of capital as well as embodied technology requires the use of skilled workers, and capital and skilled labor are complementary, the increase in inward capital will increase demand for skilled workers [Acemoglu, 2002].

Much like HOS models of trade, models of FDI usually predict different effects in advanced and developing countries. If FDI flows are directed to countries with relative abundance of low-skilled labor, this should a priori increase the demand for the abundant factor and hence have an equalizing effect in developing but a disequalizing effect in developed countries. However, less skill-intensive outward FDI from advanced countries can appear as relatively high skill-intensive inward FDI in developing countries. In that case, even when the transferred technology is “neutral,” an increase in FDI from advanced to developed countries can increase the demand for skilled labor and contribute to increasing inequality in both advanced and developing countries [Feenstra and Hanson, 2003; Lee and Vivarelli, 2006]. Further, there may be indirect disequalizing effects, even if FDI is mainly attracted by low skill-intensive countries and sectors; to attract FDI, countries may relax regulations in the field of employment protection or fiscal parameters, which otherwise would have an equalizing effect [Cornia, 2005].

Endogenous growth models such as those proposed by Aghion and Howitt [1998] or Aghion et al. [1999] assume two stages of development and inequality when new technologies are introduced: in the transition phase skilled labor demand and hence wage inequality increase before decreasing in a second stage. Such models can be adapted in terms of effects of FDI on the availability of new technologies. Figini and Görg [2006], for instance, view FDI as a vehicle for introducing new technologies. They expect that in a first step more FDI will lead to increased inequality between skilled and unskilled workers, with a reversed trend in the second step as domestic firms follow up imitating advance technologies.

What the Chapter Is About

In an integrated, world capital market with perfect information, all forms of capital flows are indistinguishable. Information frictions and incomplete risk sharing are important elements that needed to differentiate between equity and debt flows, and between different types of equities. This survey puts together models of debt, foreign direct investment [FDI], and foreign portfolio investment [FPI] flows to help explain the composition of capital flows. With information asymmetry between foreign and domestic investors, a country which finances its domestic investment through foreign debt or foreign equity portfolio issues will inadequately augment its capital stock. FDI flows, however, have the potential of generating an efficient level of domestic investment. In the presence of asymmetric information between sellers and buyers in the capital market, FDI is associated with higher liquidation costs due to the adverse selection. Thus, the exposure to liquidity shocks determines the volume of FDI flows relative to portfolio investment flows. In particular, the information–liquidity trade-off helps explain the composition of equity flows between developed and emerging countries, as well as the patterns of FDI flows during financial crises.

FDI investors get more efficient outcomes than FPI investors under their direct control over management, due to having better information about the firm's productivity, which allows them to make informed investment and management decisions. However, the better information mires FDI investors with a ‘lemons’ problem: if an investment project has to be liquidated prematurely, market participants would not know whether the firm is sold because of exogenously determined liquidity needs, or because the more informed investors find some negative aspects about the asset productivity. The consequence is that the market will place a discount on assets that a direct investor liquidates to be sold below assets that portfolio investors liquidate. The magnitude of the discount depends on the market's perception of the likelihood of a liquidity shock.

Theory predicts that the composition of foreign equity investment entails relatively more FPI and less FDI if a country is expected to experience aggregate liquidity problems. The idea is that direct investments are more costly to liquidate. Hence, expecting greater liquidity needs in the future, investors tend to tilt their investments toward the liquid asset, which is a portfolio investment. This hypothesis does not depend on the source of illiquidity faced by direct investors.

Liquidity shocks to individual investors are triggered by some country-specific aggregate liquidity shock. Individual investors are forced to sell their investments early, particularly at times when there are aggregate liquidity problems. In such times, some individual investors have deeper pockets than others, and thus are less exposed to the liquidity issues. Thus, once an aggregate liquidity shock occurs, some individual investors will need to sell, but they will get a low price because buyers do not know if they have deep pockets and sell because of adverse information or because they are truly affected by the aggregate liquidity crisis. An equilibrium property is that the composition of current flows depends on the composition of past flows. In a pooled equilibrium, where FDI investors are heterogeneous with regard to their idiosyncratic future liquidity needs, low-liquidity need investors generate negative externalities on the high-liquidity need investors. The market naturally evaluates the liquidity risk as an average between the high and the low probabilities of the shocks to liquidity. Common knowledge concerning the distribution of idiosyncratic productivity and liquidity shocks helps the market to evaluate the liquidated assets, although imperfectly, because of the information asymmetry. Thus an FDI asset is sold at a discount.

Another implication arises from the existence of information-based externality. Ideally, if the high-liquidity need investors could somehow separate themselves from the low-liquidity need investors, the former can sell their assets at a better price. But this is not possible in the pooling equilibrium. This means that high-liquidity need investors generate a positive information externality over low-liquidity need investors among direct investors. An increase in the number of FDI investors comes from high-liquidity need investors, which reinforces such externality, thereby lowering the price discount, and creating incentives for even more investors to choose to become direct investors rather than FPI investors. Pooling equilibrium is therefore characterized by strategic complementarity. A dynamic implication is that the larger the past and present share of FDI flows, the larger will also be the future share of FDI flows.

The asymmetric information between domestic investors [as borrowers] and foreign investors [as lenders] with respect to investment allocation leads to moral hazard and thus generates an inadequate amount of borrowings. The moral hazard problem, coupled with limited enforcement, can explain why countries experience debt outflows in low-income periods, in contrast to the predictions of the complete-market paradigm. Finally, a risk-diversification model is analyzed, where bond holdings hedge real exchange rate risks, while the equities hedge nonfinancial income fluctuations. An equity home bias emerges as a calibratable equilibrium outcome.

Conclusion

Despite the dire forecasts made by private bankers at the time, the end of Bretton Woods did not spell the demise of global finance. Quite to the contrary, global finance has flourished during the post-Bretton Woods era. It has also diversified, moving from what was largely foreign direct investment within the industrialized world under Bretton Woods, to also include foreign portfolio investment involving both the industrialized and developing worlds.

Why has global finance responded so positively to the absence of sustained international cooperation on monetary policy? This question is important, because the advocates for Bretton Woods and its predecessors, the classical gold standard and the gold exchange standard, had argued that such cooperation was necessary in order to bring about the stability, growth, and low inflation necessary for global finance to flourish.

One explanation, as detailed by Eric Helleiner, is the decision made by many governments in the 1960s and 1970s to relax controls on short-term international capital movements. A second, related explanation lies in financial innovation, such as the development of private markets for the trading of currencies and foreign exchange derivatives products, including the International Money Market in Chicago, Illinois. These regulatory and technological developments have allowed private firms to adjust to the post-Bretton Woods environment of exchange rate volatility.

22.2 Model Specification and Data

This study uses the hourly number of economic news headlines provided by Foreks Data Terminal to proxy the arrival of new information for the period between October 3, 2013 and March 31, 2014. News coverage is only included during weekdays and hence there is no data available for weekends.2 To measure return volatility, we utilize two indexes—BIST100 and SNM index—of Borsa Istanbul [BIST]. Hourly index data are obtained from Matriks Data Terminal. The BIST100 covers the largest 100 firms in Turkey, mostly with foreign portfolio investments that account for about 60% of traded shares, while the SNM covers small-to-medium-sized firms as well as those delisted from the National Index.3 Hence, while BIST100 includes large institutional holdings of securities, the SNM index is mostly for local investors, and by including these two indexes we want to identify differences in how the news arrival are evaluated by these two distinct investor groups.4 A recent study by Solakoglu and Demir [2014] provides sample evidence that shows the existence of sentimental herding for SNM investors and not for better-informed investors of BIST100.

Table 22.1 reports descriptive statistics on news arrivals. On average, 10 news headlines arrive to the market per hour, with a maximum of 52 news headlines per hour. The average number of daily news arrivals, not reported, is 80 during our sample, with a minimum of 29 and a maximum of 157. For both Europe and the USA, more news on output arrives to the market than inflation. For Turkish news, there does not seem to be a significant difference between news on inflation and news on output. In addition, the highest number of hourly news arrivals seems to be on Thursdays, with an average of 13.3 news headlines per hour for our sample period. The least number of news arrives on Tuesdays, with an average of 7.7 news items per hour. Although not presented in the table, the average daily return for SNM appears to be higher than for BIST100. However, the range is also much larger for SNM. In addition, the SNM index returns are more leptokurtic than for BIST100 index returns, indicating that it is more likely to observe extreme ups and downs in the market, thus pointing out that the SNM is riskier with higher return on the average than is the BIST100.

Table 22.1. Descriptive statistics

In the table, the number of economic news headlines is provided. Europe news includes news on a sample of European countries. These countries are: UK, France, Germany, Spain, and Italy.

Following earlier studies, we utilize the Generalized Autoregressive Conditional Heteroscedasticity [GARCH] models introduced by Engle [1982] and Bollerslev [1986] to test the effect of new information arrival on return and return volatility. Through the use of the GARCH model, we also expect volatility persistence to decline. That is, we will be able to observe whether some of the volatility clustering observed in the conditional volatility is due to new information. The model we estimate is provided below.

[22.1]Ri,t=μ+ϕ1D1+ϕ2D2+ϕ3D3+ϕ4D4+ ϕ5Open+∑λjNjt+εt,whereεt∼N[0,σt2]σt2=α0+α1εt−12+βσt−12+∑λjNjt

In this equation, Ri,t is the hourly index return, calculated as the log difference. The mean equation includes day-of-the-week effect as represented by day dummies D1 to D4, with Friday being the base, as well as a dummy, Open, that represents the opening hour for BIST. In both the mean and the conditional variance equation, Njt denotes measures of new information arrivals at time t for measure j, and λj denotes the associated coefficients. If the new information arrival is important, we expect λj to be statistically significant for the jth news measure. Moreover, with the new information arrival, we expect a decline in volatility persistence, as defined by the sum of coefficient estimates, α1 and β.

Globally Integrated Markets Versus Segmented Capital Markets

The world’s economies have become more interdependent since WWII due to expanding international trade. Financial markets have displayed similar interdependence or global integration such that fluctuations in financial returns in one country’s equity markets impact returns in other countries’ equity markets. Factors contributing to the long-term integration of global capital markets include the reduction in trade barriers, the removal of capital controls, the harmonization of tax laws, floating exchange rates, and the free convertibility of currencies. Improving accounting standards as well as stronger creditor protections and corporate governance also encourage cross-border capital flows. Transaction costs associated with foreign investment portfolios have also fallen because of advances in information technology and competition. Multinational companies can now more easily raise funds in both domestic and foreign capital markets. Increasingly, firms are listing on domestic as well as foreign stock markets to more easily tap global capital markets. Such cross-listing often makes such firms more likely to be targets of potential acquirers.4

These developments represent a mixed blessing for the world’s economies. Globally integrated capital markets provide foreigners with unfettered access to local capital markets and provide local residents access to foreign capital markets and ultimately a lower cost of capital. However, they also transmit disruptions rapidly in capital markets in major economies throughout the world, as evidenced by the global meltdown in the equity and bond markets in 2008 and 2009.

Unlike globally integrated capital markets, segmented capital markets exhibit different bond and equity prices in different geographic areas for identical assets in terms of risk and maturity. Arbitrage should drive the prices in different markets to be the same, since investors sell those assets that are overvalued to buy those that are undervalued. Segmentation arises when investors are unable to move capital from one market to another due to capital controls, prefer to invest in their local markets, or have better information about local rather than more remote firms.5 Investors in segmented markets bear a higher level of risk by holding a disproportionately large share of their investments in their local market as opposed to the level of risk if they invested in a globally diversified portfolio. Reflecting this higher level of risk, investors and lenders in such markets require a higher rate of return on local market investments than if investing in a globally diversified portfolio of stocks. As such, the cost of capital for firms in segmented markets, having limited access to global capital markets, often is higher than the global cost of capital.

Official Equity Market Liberalization

As a start, Bekaert and Harvey [2000a] provide an ‘official equity market liberalization’ date for each country – a date of formal regulatory change giving foreign investors the opportunity to invest in domestic equity securities and domestic investors the right to transact in foreign equity securities. In Table 3.1, we present the Bekaert and Harvey official liberalization dates for a large sample of emerging equity markets. As can be observed, many liberalizations are clustered in the late 1980s or early 1990s. Generally, these reforms involved the removal of formal restrictions on foreigners holding domestic equities; however, it should be noted that the specific dating of the key regulatory action is not without some judgement and that there are other ‘equity market liberalization’ dates provided in the literature which, employing somewhat different criteria, do differ significantly for some countries from those provided here [see Henry, 2000a; Kim and Singal, 2000; Levine and Zervos, 1998b].

Table 3.1. Equity Market Liberalization

To illustrate the difficulty associated with dating market integration, it should be acknowledged that emerging countries pursued a multifaceted reform effort by [in some cases simultaneously] introducing insider trading laws, undertaking key macroeconomic reforms, employing varied exchange rate regimes, and gradually allowing both foreign direct and portfolio investment. Taken together, the nature of the reform effort makes the dating of economic and financial integration a matter of judgment, particularly, as researchers are particularly interested in isolating the financial and economic effects of an equity market liberalization [see Bekaert et al., 2001, 2005]. Unfortunately, the simultaneity of macroeconomic, political, and financial reforms is not the only factor potentially confounding an examination of a single reform's key economic effects. In practice, there are additional factors that may cloud the importance of any one particular regulatory change. In this instance, it is possible that the investment restrictions were not binding before the reform. Second, the official regulatory changes permitting foreign investment are often implemented gradually. Brazil, as an example, rewrote its foreign investment law in May 1991, allowing foreign institutions to own up to 49% of voting stock and 100% of nonvoting stock; only later did Brazil permit greater degrees of foreign ownership. Dating the ‘official liberalization’ is by no means unambiguous. Third, although countries might undertake official regulatory reform efforts, foreign investors may still avoid markets based on other perceived impediments. When one starts from the segmented state, the barriers to investment are often numerous. Bekaert [1995] details three different categories of barriers to emerging market investment: [1] legal barriers; [2] indirect barriers that arise because of information asymmetry, accounting standards, and investor protection; and [3] risks that are especially important in emerging markets, such as liquidity, political, economic policy, and currency risk. These barriers discourage foreign investment, and it is unlikely that any/all of these barriers disappear at a single point in time [if ever]. This latter question pertains to the efficacy of the reform effort rather than simply its precise timing. Some of these dimensions are explored below.

Globally Integrated versus Segmented Capital Markets

While both developed and emerging country economies have become increasingly interdependent in recent years, there also is substantial evidence that regional and individual country capital markets have become increasingly integrated. Reflecting the emergence of a global capital market, correlation among individual countries' capital markets, on average, has increased [Bekaert and Harvey, 2002]. For example, in 2005, foreigners held 12 percent of U.S. stocks, 25 percent of U.S. corporate bonds, and 44 percent of U.S. Treasury securities, as compared to 4, 1, and 20 percent, respectively, in 1975 [Farrell, Key, and Shavers, 2006]. Reflecting this increasing integration among country capital markets, correlation between the performance of U.S. and European stocks has increased from less than 30 percent in the 1970s to 90 percent in recent years [Blackman, 2006].

Globally integrated capital markets provide foreigners with unfettered access to local capital markets and local residents to foreign capital markets. Factors contributing to the integration of global capital markets include the reduction in trade barriers, removal of capital controls, the harmonization of tax laws [which reduce the impact of different tax rates on trade and investment], floating exchange rates, and the free convertibility of currencies. Improving accounting standards and shareholder protections [i.e., corporate governance] also encourage cross-border capital flows. Transaction costs associated with foreign investment portfolios have also fallen because of advances in information technology and competition. Consequently, multinational corporations can more easily raise funds in both domestic and foreign capital markets. This increase in competition among lenders and investors has resulted in a reduction in the cost of capital for such firms.

Unlike globally integrated capital markets, segmented capital markets exhibit different bond and equity prices in different geographic areas for identical assets in terms of risk and maturity. Arbitrage should drive the prices in different markets to be the same, as investors sell those assets that are overvalued to buy those that are undervalued. Segmentation arises when investors are unable to move capital from one market to another due to capital controls or simply because they prefer to invest in their local markets. Segmentation or local bias may arise because of investors having better information about local rather than more remote firms [Kang, 2008].

Investors in segmented markets bear a higher level of risk by holding a disproportionately large share of their investments in their local market as opposed to the level of risk if they invested in a globally diversified portfolio. Reflecting this higher level of risk, investors and lenders in such markets require a higher rate of return to local market investments than if investing in a globally diversified portfolio of stocks. Therefore, the cost of capital for firms in segmented markets without easy access to global markets often is higher than the global cost of capital.

Despite the increasing correlation of cash flows and share prices among firms in developed countries, there is evidence that capital markets in these countries may be segmented to the extent that local factors are more important in determining the cash flows, access to capital, and share prices of small firms than of large firms [Eun, Huang, and Lai, 2007]. Consequently, the share price of a major French retailer like Carrefour may trade very much like the giant U.S. retailer Wal-Mart. However, the stock of a small French retail discount chain, affected more by factors in its local market segment, may trade differently from either Carrefour or Wal-Mart and exhibit a much higher cost of capital.

3.4 Consequences of Shareholder Protection

Perhaps the central message of law and finance research is that legal protection of shareholders and creditors has substantial implications for the organization and development of capital markets. We begin with legal protection of shareholders.

Several studies have analyzed different aspects of shareholder protection. Better shareholder protection has been shown to increase firm valuation [Aggarwal et al. 2009; Albuquerue and Wang, 2008; Dahya, Dimitrov, and McConnell, 2008; Durnev and Kim, 2005; La Porta et al. 2002b], to increase dividends [La Porta et al. 2000], to encourage value-improving risk-taking [John, Litov, and Yeung, 2008], to increase firm access to external finance [Demirguc-Kunt and Maksimovic, 2002], to reduce earnings management [Goto, Watanabe, and Xu, 2009; Leuz, Nanda, and Wysocki, 2003], to improve governance ratings [Doidge, Karolyi, and Stulz, 2007], to increase market liquidity [Brockman and Chung, 2003; Eleswarapu and Venkataraman, 2006; Lesmond, 2005], to influence corporate cash holdings [Kalcheva and Lins, 2007; Pinkowitz, Stulz, and Williamson, 2006], to improve gains to acquirers in cross-border acquisitions [Bris, Brisley, and Cabolis, 2008; Chari, Ouimet, and Tesar, 2010; Ellis et al. 2011], and to promote the mutual fund industry [Khorana, Servaes, and Tufano, 2005, 2009] and foreign portfolio investment [Leuz, Lins, and Warnock, 2009].

An interesting group of papers in this area considers the relationship between investor protection and the efficiency of capital allocation [Almeida and Wolfenzon, 2005, 2006; Beck, Demirguc-Kunt, and Maksimovic, 2008; Beck and Levine, 2002; Braun and Larrain, 2005; Rajan and Zingales, 1998; Wurgler, 2000]. Rajan and Zingales [1998] in particular pioneered an important line of research which distinguishes among industries with different levels of financial dependence, and considers the relative growth of such industries as a function of the level of financial development in a country.

Another significant strand of work looks at the so-called bonding hypothesis, the idea that a company can commit to an investor-friendly regime by cross-listing in an investor-friendly country, such as the United States. Reese and Weisbach [2002] show that equity offerings increase subsequent to cross-listing in the US, especially for firms from countries with poor shareholder protection. Doidge, Karolyi, and Stulz [2004] show that such cross-listing is associated with higher valuations, and argue that it represents a commitment to reduced investor expropriation. In a similar spirit, Doidge [2004] shows that cross-listing in the US is associated with a lower voting premium. Further evidence for the bonding hypothesis is provided by Doidge, Karolyi, and Stulz [2009], Hail and Leuz [2009], Sarkissian and Schill [2009], Lel and Miller [2008], Fernandes, Lel, and Miller [2010]. Siegel [2005] however offers some contrary evidence by pointing out that the United States does not enforce its securities laws against Mexican firms cross-listed in the US, so these firms do not get all the benefits of US laws. One further finding of this research is that controllers of firms with really high private benefits of control do not wish to list in the United States [Doidge et al. 2009], and even chose to delist after the passage of the Sarbanes–Oxley Act, which further constrained tunneling. The cross-listing evidence is broadly consistent with cross-country evidence in documenting the importance of minority shareholder protection for a variety of corporate outcomes.

6.1 Stock Markets

Since the 1990s the World Bank has actively promoted stock market development among African countries through its affiliate, the International Finance Corporation [IFC], which provides technical expertise to advance this process. This has been justified on the basis that stock markets are part and parcel of the development of the financial sector as whole. Furthermore, emerging stock markets are seen as useful vehicles for attracting foreign portfolio investments and mobilizing savings for economic development.

In 1990 there were merely six stock markets in sub-Saharan Africa – Ghana, Kenya, Mauritius, Nigeria, South Africa and Zimbabwe – and three in North Africa – Egypt, Morocco and Tunisia. By the end of 2015, there were 28 stock exchanges representing 38 African capital markets. These 28 stock exchanges are located in the following countries: Algeria; Botswana; Bourse Régionale des Valeurs Mobilières [BRVM] is headquartered in Côte d’Ivoire [serving Benin, Burkina Faso, Côte d’Ivoire, Guinea Bissau, Mali, Senegal and Togo]; Bourse Régionale des Valeurs Mobilières d'Afrique Centrale [BVMAC] is headquartered in Gabon [serves Central Africa Republic, Chad, Equatorial Guinea, Gabon and Republic of Congo]; Cameroon, Cape Verde, Egypt, Ghana, Kenya, Libya, Malawi, Mauritius, Morocco, Mozambique, Namibia, Nigeria, Rwanda, Seychelles, Sierra Leone, Somalia, South Africa, Sudan, Swaziland, Tanzania, Tunisia, Uganda, Zambia and Zimbabwe.

Despite this rapid development, stock markets in Africa are still shallow, small in size and suffer from low liquidity with the exception of the Johannesburg Securities Exchange, which is the most active bourse on the continent. In 2015, it represented slightly over three-quarters of the combined US$ 1 trillion market capitalization of indices in Africa. When we measure the extent to which stock markets are serving the needs of African companies using initial public offering [IPO] data for the period 2013 to 2015, it can be observed that there were over 70 IPOs, and African companies raised capital in excess of US$ 4 billion [see Table 5.2].

Table 5.2. Initial Public Offerings [IPOs] by African Stock Exchanges.

[i] BRVM serves Benin, Burkina Faso, Côte d’Ivoire Guinea-Bissau, Mali, Senegal and Togo; [ii] BVMAC serves Central Africa Republic, Chad, Equatorial Guinea, Gabon, and Republic of Congo.

PwC [2016b].

Generally, the financial sector dominates the African IPO market with about 48% of the total value going to the sector, while the consumer goods and healthcare sectors account for 17% and 8% respectively. The industrials sector follows with 7%, and telecommunications accounts for 5% of the total IPO market. The other four sectors, viz basic materials, oil and gas, utilities and technology, share the remaining 15% of the total African IPO market.

Insofar as there has been sustained growth in the listings of companies on the African stock exchanges, the number of IPOs per year are still few compared with other regions of the developing world, with the exception of Latin America and the Caribbean. For example, in 2015 there were 1218 IPOs around the world which raised combined capital amounting to US$ 195.5 billion [EY, 2015]. Of the 1218 IPOs, 12 were issued in central and south America, 28 in Africa, 58 in the Middle East and India, 188 in North America, 259 in Europe, and 673 in the Asia–Pacific [EY, 2015].

Generally, African stock markets do not provide a platform for start-ups and small businesses to raise capital. This leaves the SMEs and start-ups to rely on banks as a source of financing. On the other hand, banks in Africa shun the SME sector relative to other developing regions of the world. Bank lending often focuses on large corporate clients and on key sectors of the economy [manufacturing, trade, real estate and construction]. According to the World Bank Enterprise Survey of 2014, over 90% of SMEs in Africa lack access to credit. This is attributed to high-risk characteristics of SMEs.

Stock markets in Africa are growing but at a slow pace. The many contributing factors to this slow growth include [1] low liquidity caused by few listed firms that trade infrequently; [2] weak legal and regulatory environments, [3] lack of robust electronic trading systems; and [4] few participating institutional investors. Overcoming these challenges would significantly contribute to the growth of stock markets in Africa.

Despite challenges, African stock markets have the potential to be a barometer of the economy and offer great investment opportunities. The future prospects of African stock markets look bright judging from recent developments. First, through increased participation of banks and pension funds as institutional investors, liquidity is on an upward trajectory. Second, the rising middle class in Africa is showing an appetite for stock market investment, thereby increasing the number of participants. Third, macroeconomic and political stabilization have been accompanied by improvements in the regulation and sophistication of stock trading systems.