Article: Monday, 20 March 2017

Successful financial markets can help grow emerging economies, says Professor Mathijs van Dijk of Rotterdam School of Management (RSM). But new stock markets also regularly fail to take off, so when are the conditions right for establishing one? A new study by Van Dijk and a team of researchers reveals what ultimately makes stock markets flourish. Early success of the stock markets turns out to be a necessary condition. A solid banking sector and growing national savings predict success in the long run, they found. The result can provide insights to the 49 –mostly developing- countries worldwide that currently do not have a stock market.

What makes new stock markets successful?

Stock markets allow consumers and institutions to shift capital to where it creates the most value, says van Dijk. The investment options that a stock market creates, can also stabilise household income and company revenues that often fluctuate in emerging economies. That’s why opening a stock market could potentially be very beneficial for a country with such an emerging economy.

...60 percent of the variation in the eventual success of the stock market could be explained by their success early on, and by conditions already present at the time of establishment.

The right conditions

But a failing stock market can also damage a country’s reputation and undermine trust in its financial institutions. So, for countries that are still on the fence about opening a stock market, knowing whether and when the conditions are right for opening one is key.

The researchers first charted the success of 59 stock markets that have been established in developing countries since 1975. Success of these financial markets was measured by looking at the number of firms listed on the stock market, the size of the stock market, and the level of trading activity. The researchers tracked the success of these stock markets over the forty years after their establishment. The results show that while some stock markets flourish, others perish after initial success or essentially remain dormant.

Early success

To find out what conditions predict success after twenty years, the researchers then studied a wide range of indicators relating to the countries and their economies. They found that 60 percent of the variation in the eventual success of the stock market could be explained by their success early on, and by conditions already present at the time of establishment.

Necessary but not sufficient

Interestingly, further analysis of that early success showed that to be successful in the long run, a stock market needs to have a minimum number of listings – roughly around fifteen – in the first five years. At the same time, roughly seven per cent of the listed shares need to be traded every year during that period. Stock markets that do not meet these conditions fail to thrive later on. Other factors cannot compensate it. The researchers discovered this by using a statistical technique called Necessary Condition Analysis (NCA), developed by RSM’s Jan Dul. But this early success – however necessary – does not ultimately guarantee success. That is determined by other conditions.

Banking sector

By looking closely at specific conditions at the time the stock market was established, researchers found that the size of the country’s banking sector is a strong predictor of later success. This confirms earlier ideas that in flourishing economies, a well-functioning financial market is complemented by a healthy banking sector.

National savings

The researchers also found that nascent stock markets develop well if national savings also grow. Van Dijk says this indicator is often seen as a proxy for investor demand. In other words: a high level of savings creates the need and ability to shift funds to investment opportunities like stocks and other financial products.

Good governance

This shows that the success of stock markets is largely predicted by so-called ‘policy factors’, says Van Dijk. These are aspects of the economy that can be influenced by governance. The banking sector can be stimulated to grow, for example, by allowing private or foreign banks to develop activities. Structural factors on the other hand, which are inherited and mostly fixed characteristics such as population size and political system, did not have any effect on the ultimate success of a stock market, the results showed. This demonstrates that the success of a new stock market can be influenced by good governance, Van Dijk concludes. J. (Jan) Dul
Professor of Technology and Human Factors
Rotterdam School of Management (RSM)
Erasmus University Rotterdam
Jan Dul
prof.dr. M.A. (Mathijs) van Dijk
Professor of Financial Markets
Rotterdam School of Management (RSM)
Erasmus University Rotterdam
Mathijs van Dijk
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