european journal of economics, finance and administrative sciences

5 European Journal of Economics, Finance And Administrative Sciences - Issue 8 2007 European Journal of Economics, Finance and Administrative Sciences Issue 8 October, 2007 Contents

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1 European Journal of Economics, Finance And Administrative Sciences - Issue 8 (2007)

EUROPEAN JOURNAL OF ECONOMICS, FINANCE

AND ADMINISTRATIVE SCIENCES

ISSN: 1450-2275 Issue 8

October, 2007

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EUROPEAN JOURNAL OF ECONOMICS, FINANCE AND ADMINISTRATIVE SCIENCES http://www.eurojournals.com/EJEFAS.htm

Editor-In-Chief

Adrian M Steinberg, Wissenschaftlicher Forscher

Editorial Advisory Board

Bansi Sawhney, University of Baltimore

Jwyang Jiawen Yang, The George Washington University

Zhihong Shi, State University of New York

Zeljko Bogetic, The World Bank

Jatin Pancholi, Middlesex University

Christos Giannikos, Columbia University

Hector Lozada, Seton Hall University

Jan Dutta, Rutgers University

Chiaku Chukwuogor-Ndu, Eastern Connecticut State University

Neil Reid, University of Toledo

John Mylonakis, Hellenic Open University (Tutor)

M Femi Ayadi, University of Houston-Clear Lake

Emmanuel Anoruo, Coppin State University

H Young Baek, Nova Southeastern University

Jean-Luc Grosso, University of South Carolina Sumter

Richard Omotoye, Virginia State University

Mahdi Hadi, Kuwait University

Jean-Luc Grosso, University of South Carolina

Ali Argun Karacabey, Ankara University

Felix Ayadi, Texas Southern University

Bansi Sawhney, University of Baltimore

David Wang, Hsuan Chuang University

Cornelis A Los, Kazakh-British Technical University

Leo V Ryan, DePaul University

Richard J Hunter, Seton Hall University

Said Elnashaie, Auburn University

Panayiotis Tahinakis, University of Macedonia

Mukhopadhyay Bappaditya, Management Development Institute

M Carmen Guisan, University of Santiago de Compostela

Subrata Chowdhury, University of Rhode Island

Teresa Smith, University of South Carolina

Wassim Shahin, Lebanese American University

Mete Feridun, Cyprus International University

Teresa Smith, University of South Carolina Sumter

Ranjit Biswas, Philadelphia University

Katerina Lyroudi, University of Macedonia

Maria Elena Garcia-Ruiz, University of Cantabria

Zulkarnain Muhamad Sori, University Putra Malaysia

Indexing / Abstracting

European Journal of Social Sciences is indexed in Scopus, Elsevier Bibliographic Databases,

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Aims and Scope

The European Journal of Scientific Research is a quarterly, peer-reviewed international research journal that addresses both applied and theoretical issues The scope of the journal encompasses research articles, original research reports, reviews, short communications and scientific commentaries in the fields of economics, finance and administrative sciences

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European Journal of Economics, Finance and Administrative Sciences is published in the United States

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European Journal of Economics, Finance and Administrative Sciences

Issue 8

October, 2007

Contents

Stock Market Trends, Day of the Week Effect and Investor’s Behavior after

Dimitris Balios and Sophia Stavraki

Readability of Financial Statement Footnotes of Kuwaiti Corporations 18-28Aly M Hewaidy

An Application of Optimum Currency Area (OCA) Analysis to Egypt 29-38Sherine El Hag

Openness-Inflation Puzzle for Pakistan: Under Two Alternative Approaches 39-50Khalil Ahmad and Muhammad Shahbaz

Mahmoud Khalil, Shereef Ellaboudy and Arthur Denzau

Panayotis Alexakis

Trends in the Market Growth for Proton Exchange Membrane Fuel Cells (PEMFC):

Cihat Polat and Nurcan Kılınç

Highly Leveraged Firms and Corporate Performance in Distressed Industries 93-101Anna Merika, Theodore Syriopoulos and Christos Negakis

Reengineering America- PART I: The Socioeconomic Costs of Urban Sprawl:

A Socioeconomic Analysis of Exploitative Cross-Industry Diversification Strategies 102-113Syrous K Kooros and George Alexakis

Economic Changes that Effect the Probability of Success in R&D 114-127Nissim Ben-David

Young Adult Perception Towards Celebrity Endorsement:

A Comparative Study of Single Celebrity and Multiple Celebrities Endorsement 128-139Farida Saleem

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ISSN 1450-2887 Issue 8 (2007)

http://www.eurojournalsn.com

Stock Market Trends, Day of the Week Effect and Investor’s

Behavior after the September’s 2001 Attacks

Dimitris Balios

Department of Economics University of Piraeus 80, Karaoli and Dimitriou st

185 34 Piraeus, Greece E-mail: dbalios@econ.uoa.gr

Keywords: Day of the week effect, market efficiency, international financial markets,

stock market trends, investor’s behavior

Jel Classification Codes: G10, G14, G15

I Introduction

According to Fama (1976), a market is efficient if prices fully and instantaneously reflect all available information and no profit opportunities are left unexploited In an efficient situation, new information is unpredictable, so stock market returns cannot be predicted and there is therefore no trading pattern, which an investor can follow in order to make unexpected profits

The day of the week effect refers to the existence of a pattern of stock returns during the week,

a seasonal «anomaly», which contradicts the «Efficient Market Hypothesis» Cross (1973) and French (1980) were the first to observe a specific seasonality in stock returns during the week, that was named

«Day of the Week Effect» According to this phenomenon, the average stock market return on the last trading day of the week (Friday) is positive and is the highest across all days of the week and the return

on the first trading day of the week (Monday) is negative and is the lowest across the same period

As we report in the literature review in the next session, all these studies examine the existence

of the phenomenon in a specific period This study comes to examine the phenomenon, of course during a specific period, but in addition, we divide this period in parts according to the market trend

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7 European Journal of Economics, Finance And Administrative Sciences - Issue 8 (2007)

Balios and Xanthakis examined the existence of the phenomenon for the period January 1994 – August

2001, dividing this period in a sideway period, in an uptrend period and a downtrend one They found that the week effect tends to fall away from the classical «Day of the week effect» possibly because investors adjust their behavior in the previous findings in a way balancing the pattern of returns In the sideway period, they find that there is no particular pattern of returns for the indices and the disinterest

in dealing in the stock market to be a reason for this efficient pattern of returns They supported that in the uptrend period, investors are very optimistic for the price walk and the companies try to boost this trend That’s why they find positive returns (in most of the indices) on Fridays and Mondays something that maybe is happening because companies announce or are expected to announce their good news during the week and investors try to take positions from Friday to Monday so that they could profit from the difference from the next week’s higher expected price Finally, in the downtrend period, they find a strong Wednesday negative effect in all indices They support that in downtrend periods there is

a waiting attitude from investors for good news like the rate of interest which is determined by the European Central Bank (ECB) They conclude that Wednesday is one day before the bank meeting and

a day that investors could incorporate in their behavior the ECB ‘s expected action which has to do with the denial to reduce the interest rates for the examined period

In this study we examine the phenomenon for the period after the September’s 2001 attacks in the USA for six European Stock Indices We are interested in finding how investors react after the attacks, how their trading behavior influences the «Day of the week effect», and finally we compare these results with the Balios and Xanthakis results

The rest of the paper is organized as follows Section II provides the literature review Section III contains the data and methodology Section IV contains the empirical results and in Section V the conclusions of the paper are reported

II Literature Review

The first studies that indicated the day of the week effect were written for the major stock markets, like the US markets For the US markets, except from Cross (1973) and French (1980), day effects or daily anomalies have also been mentioned by Gibbons and Hess (1981), Lakonishok and Levi (1982), Rogalski (1984), Keim and Stambaugh (1984), Smirlock and Starks (1986), Harris (1986), Lakonishok and Smidt (1988) Since then, similar results have been found in several stock markets inside and outside the United States In this literature review we emphasize in studies after 2001

In recent studies, several researchers have investigated the seasonality of the day of the week effect Chen et al (2001) examine the day of the week effect in the stock markets of China for the recent years They find negative returns on Tuesday Even though the results of this paper support the evidence of the day of the week effect, they content that this evidence depends on the estimation method and sample period When the transaction costs are taken into account, the opportunity for arbitrage profits from the day of the week effect seems to be very small The conclusion is consistent with the efficient market; there is no clear evidence of the day of the week effect

Kiymaz and Berument (2003) investigate the day of the week effect on the volatility and return

of major stock markets (German, Japan, US, Canada and United Kingdom) for the time period from

1998 to 2002 Their findings are consistent with the day of the week effect both for returns and volatility

In addition, there are many studies that examine the day of the week effect at the emerging markets Cabello and Ortiz (2004) investigate the day of the week and month of the year effect for Latin America stock markets The paper supports the existence of calendar anomalies They find the lowest and negative returns on Mondays and high returns on Fridays

Hui (2005) examines the day of the week effect at Asian-Pacific markets during the period of Asian financial crisis and also tests the presence of weekend effect in developed stock markets of US

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and Japan The paper supports no evidence of the day of the week effect in capital markets for the

recent years, in both Asian Pacific and US capital markets Holden et al (2005) examine the day of the

week effect for the daily returns of stock market index of Thailand during the period of Asian financial

crisis This study uses a general model for the test of anomalies included not only the day of the week

effect but also the month of the year and days after holidays and within month effects The conclusion

of the test performed is that the calendar effects improve the forecast accuracy for daily returns

Joshi and Bahadur (2006) study the day of the week effect empirically in the Nepalese stock

market for daily data of Nepal Stock Exchange Index from 1995 to 2004 They find persistent evidence

of day-of-the-week anomaly, and they also document no evidence of month-of-the-year anomaly and

half-month effect Their result for the month-of-the-year anomaly is consistent to the finding observed

for the Jordanian stock market and that for the day-of-the-week anomaly to the Greek stock market

Patev et al (2003) examine the presence of the day-of-the-week effect anomaly in the Central

European stock markets during the period 1997 to 2002 Their results indicated that the Czech and

Romanian markets have significant negative Monday returns while the Slovenian market has

significant positive Wednesday returns and has non-significant negative returns on Fridays The Polish

and Slovak markets have no day-of-the week effect anomaly Lyroudi et al (2002) examine empirically

the day of the week effect anomaly in the Athens Stock Exchange (ASE) for the period 1994 to 1999

Their results indicated that the day of the week effect is strongly observed in the Greek Stock market

during the second sub period (1996-1999) Chukwuogor-Ndu (2006) reported the existence of the

phenomenon in the BVSP index (Brazil), but not for MRVE (Argentina) and MXSE (Mexico) indices

III Data and Methodology

1 Data

The data set used in this study consists of six European Index values In particular, the six indices used

are, FTSE 100, GDAX 30, CAC 40, Madrid General, MibTel and ASE General corresponding to,

United Kingdom, Germany, France, Spain, Italy and Greece, respectively The data used in this study

concerns the period from Monday 1st October of 2001 to Friday 2nd February of 2007 and is obtained

directly from their stock exchanges The examined period consists of 279 weeks, so the created data

series has 1395 observations For econometric reasons, for working days that the stock markets did not

open and of course the indices did not change, the value of the previous day has been used

The whole period from October 2001 to February 2007 has been divided into 2 subperiods

based on a different market trend The trend of an index or a value can be upward, downward or

sideway An uptrend movement of stock market indices is characterized by an uptrend pattern of prices

that, in our case, can be easily observed in their graphs Because of the almost same date reversal of

European stock market’s trend, we chose the same sub-periods for the six European indices, so the

observations used for the econometric analysis are the same The time period and the number of

observations used for each market are shown in Table 1

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The returns used in each of the time series are computed as follows:

1 t

t

Pn

r

−

= l

rt : the day return

Pt : the value of the index

Pt-1 : the value of the index the previous working day

2 Methodology

A test of a day of the week effect is a market efficiency test, which is based on return data series A stock value is changing because of the arrival of new information The way new information is coming

to the market is not constant, so the conditional variance of the daily price change is considered to be

an increasing function of the rate at which new information enters the market What one must take into account is that the variance is time dependent and in order to produce the appropriate asymptotic distributions, one must correct the time series from heteroskedasticity The best way to correct a model from the non-constant heteroskedasticity is the GARCH(p,q) models, where p refers to the squared error terms and q to the lag on variance (Bollerslev, 1986)

The model employed can be written as:

rt = b1Mo + b2Tu + b3 We + b4Th + b5Fr + ci rt-i + ut

with ut = σtzt, zt ~ i.i.d with E(zt) = 0 and Var(zt) = 1 and σ2t = Var(rt/It-1) the conditional variance based on the information set It-1 The use of a lagged observation of the return (if it is useful) happens

in order to correct the model from autocorrelation

The method used for the estimations was the OLS (Ordinary Least Squares) method and whenever heteroskedasticity was present, the method used was the maximum likelihood and the GARCH(p,q) models (the econometric software used for the model estimation was E-views)

In the model, the variables Mo, Tu, We, Th, Fr are the dummy variables of Monday, Tuesday, Wednesday, Thursday and Friday, respectively For example, the Mo dummy variable, takes the value

of 1 if the observation falls on Monday and zero in all other cases The disturbance error term is depicted by ut The coefficients b1 to b5 are the mean returns for the five trading days

As it has been mentioned before, in an efficient market there will not be a pattern in returns during the week, so the unexpected return for each day of the week will be the same and close to zero and the z-statistic measuring the significance of the dummy variables will be small enough for the dummy variables to be statistically significant If an estimator is statistically significant (5% level of significance), we conclude the existence of a day of the week effect which is evidence for inefficiency

IV Descriptive Statistics

Table 2 presents descriptive statistics for the whole period data series FTSE 100 index has the lowest return (0.018%) and the General Madrid index has the biggest one (0.058%), while the MibTel index has the lowest standard deviation (1.025%) and the GDAX the biggest standard deviation (1.579%) among all indices The kurtosis measures indicate that the return series are leptokurtic compared to the normal distribution Table 2 also reports the Augmented Dickey - Fuller statistics for both the logarithm of the stock prices and the logarithmic first differences (returns) The hypothesis of a single unit root in the logarithm of the stock prices is accepted, but is strongly rejected in the logarithmic first differences

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** denotes significance at the 1% level of significance

In Table 2A we can study descriptive statistics for the downtrend period data series GDAX index has the lowest return (-0.137%) and the biggest standard deviation (2.432%) among all indices For this subperiod too, the hypothesis of a single unit root in the logarithm of the stock prices is accepted, but is strongly rejected in the logarithmic first differences

Table 2B presents mean returns, standard deviations and other descriptive statistics for the uptrend period data series ASE index has the biggest return (0.114%) and GDAX has the biggest standard deviation (1.075%) among all indices For the uptrend period too, the hypothesis of a single unit root in the logarithm of the stock prices is accepted, but is strongly rejected in the logarithmic first differences

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Very interesting are the descriptive statistics for each day of the week Tables 3A and 3B

present mean returns and standard deviations respectively, for each day of the week for the whole

period data series Mean returns are the highest on Thursday for all stock indices, while Monday has

the lowest returns for all indices, too A summary of these results is displayed in table 3 From equality

tests for the mean returns across all days of the week, we don’t conclude the rejection of the hypothesis

that mean returns among the days of the week are equal, except from ASE General Table 3B presents a

summary of the standard deviations It is observed the highest standard deviation on Monday for all

indices and the lowest on Friday for all indices, too The Levene test, which measures the equality of

variance in returns, shows that risk is distributed equally among the weekdays except for MibTel

Table 3A: Mean returns on common stocks indices by day of the week for the whole examined period

The F-Stat refers to the F-Statistic of the Equality of means test

If p-value < 0.050, then the hypothesis of equal means is rejected

Table 3B: Standard deviation on common stocks indices by day of the week for the whole examined period

The L-Value refers to the Levene Value of the Equality of variance test If p-value < 0.050, then the hypothesis of equal variances is rejected

Tables 3C and 3D present the same descriptive statistics but for the downtrend period data

series this time Mean returns are lowest on Wednesday for FTSE 100, while for the rest stock markets,

mean returns are lowest on Monday Standard deviations are highest on Monday for FTSE 100, GDAX

and General Madrid index, on Thursday for CAC 40 and MibTel, while ASE has the highest standard

deviation on Wednesday From equality tests across all days of the week we accept the null hypothesis

that means and standard deviations are equal in each subgroup

Table 3C: Mean returns on common stocks indices by day of the week for the downtrend examined period

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Table 3D: Standard deviation on common stocks indices by day of the week for the downtrend examined

The L-Value refers to the Levene Value of the Equality of variance test If p-value < 0.050, then the hypothesis of equal variances is rejected

Studying Tables 3E and 3F which present mean returns and standard deviations for each day of

the week for the uptrend period data series we conclude that mean returns are highest on Friday for

FTSE100, CAC and ASE, on Monday for GDAX, while for the rest stock markets, mean returns are

highest on Wednesday Standard deviations are highest on Monday for all stocks From equality tests

across all days of the week we accept the null hypothesis that means are equal in each subgroup, but we

reject it for the standard deviations as it does not hold for DAX, MibTel and General Madrid

Table 3E: Mean returns on common stocks indices by day of the week for the uptrend period

Table 3F: Standard deviation on common stocks indices by day of the week for the uptrend period

The results of the regressions are presented in tables 4A, 4B and 4C The estimation of the regressions

has been done by maximum likelihood method because heteroskedasticity was always present The lag

lengths used for the conditional mean were determined on the basis of the Schwarz and Akaike

criterion To avoid autocorrelation, the use of lagged return observations was necessary (in some of the

regressions)

As we examine the results of the whole period (Table 4A), not only we don’t find strong

evidence for the existence of the classical day of the week effect, but there is no any obvious pattern in

coefficient’s significances For FTSE 100, DAX and CAC, the only statistical significant coefficients

are that of FTSE 100 on Friday and of DAX on Monday Wednesday is positive for MibTel and for

General Madrid and ASE General there are positive, statistically significant coefficients on

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Wednesday-Thursday and Thursday-Friday respectively All the significant coefficients are positive

There is no classical version of the day of the week effect (Fridays with positive returns and Mondays

with negative returns and no substantial day effect for the developed stock markets

Table 4A: Regression results - whole period

* denotes significance at the 5% level of significance

Of particular interest are the findings for the downtrend period (Table 4B) There are only two

statistically significant negative coefficients Only the Tuesday returns for FTSE 100 and the Monday

returns for ASE General are statistically significant Not only we can not find strong evidence for the

existence of specific day of the week effect for the downtrend period, but the markets, in a risky period

because of the economic environment that after the September’s 2001 attacks has been configured, look

they work efficiently

Table 4B: Regression results – downtrend period

Examining the uptrend period (results in Table 4C) we find a few statistically significant

positive coefficients Just like the whole period, for FTSE 100, DAX and CAC, the only statistically

significant coefficients are that FTSE 100 on Friday and that of DAX on Monday The results are

different for the less developed stock markets than these of the previous ones For Madrid General, the

coefficients that are statistically significant are these of Monday, Wednesday, Thursday and Friday

which have a positive sign, as the returns Wednesday, Thursday and Friday for ASE General Finally,

Wednesday is positive for MibTel We conclude that, in the uptrend period, there is no classical day of

the week effect The results from the most developed stock market’s indices are an evidence for market

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efficiency as no trading pattern can be created From the less developed stock market’s indices like

General Madrid and ASE General, the uptrend movement of the prices seems that have influence in the

same way almost the whole week In general, the results of the uptrend period seem that have influenced these of the whole period as it’s almost the same

Table 4C: Regression results – uptrend period

The statistical significance of mean returns indicates that past returns influence the current

returns If the past returns influence the current returns, then there is violation of the Martingale

Hypothesis, according to which, information from past returns is useless in predicting future returns If

this violation is true, it constitutes evidence of market inefficiency The Martingale Hypothesis is

violated only for the case of FTSE and ASE General in the whole and in the uptrend periods (and CAC

in the uptrend too) In all the other indices the regression results show that past returns do not have any

influence on future returns

VI The Conclusions

In this study we examine the existence of the phenomenon «Day of the Week Effect» in six European

Indices after the September’s 2001 attacks in USA, dividing the whole period according to the stock

market‘s trend

Balios and Xanthakis didn’t find specific day of the week effect for the period January 2004 to

August 2001 for the same indices, but examining the same period based on the stock market’s trend

they concluded that in four out of six indices there is no day effect in the sideway period, there are

many statistically significant positive coefficients in the uptrend period and a strong negative Wednesday effect in all the examined indices in the downtrend period

As we examine the same phenomenon for the period October 2001 – February 2007 we

conclude that not only there is no classical day of the week effect but the phenomenon seems to

disappear from the developed stock markets and not to have a specific pattern in general

Nowadays, the stock markets are more liquid than ever and seem to be more efficient that the

previous decades because of the easiest capital transmission, the technological changes and the changes

in the stock market microstructure So, it is logical for investors to react more mature, something that

induces less inefficient results This is clear for the more developed stock markets and the indices of

DAX, FTSE and CAC as we consider the coefficient’s statistical significances and less clear for the

indices of MIBTel, General Madrid and ASE General

Investor’s behavior looks more mature as we study the results of the downtrend and the uptrend

period and we compare them with the results of Balios and Xanthakis Before the September’s 2001

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attacks, in the downtrend period, there was a negative Wednesday effect Balios and Xanthakis support that this finding is a result of the waiting attitude of the investors for good news and especially the rate

of interest After September 2001, in the downtrend period, we don’t find any effect during the week (except for ASE on Monday) This period is characterized by hesitance and wariness because investors are not interested only to clear economic events but to political – terrorism news too So investor’s behavior is characterized by behavioral trading, no specific trading strategy and a waiting attitude for political – economical stability As a result, there is no day of the week effect, something that changes

in the uptrend period

When investors feel more secure about the political – economical environment, there optimism boosts prices to higher levels and most of the trading sessions have a positive sign at the end of the day Our findings fit with Balios and Xanthakis results as the indices of the developed stock markets do not have (or have at the most one) day effect in the uptrend period In less developed stock markets the phenomenon exists but not in a specific pattern

Finally, we conclude that the phenomenon of the «Day of the Week Effect» seems to be weaker than it was in previous decades as a result of investor’s behavior Investors are more mature, well educated, with more professional attitude, characteristics that help stock markets to become more efficient

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nontrading period”, Journal of Finance, 39, 1603-14

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25] Schwarz, G (1978), “Estimating the Dimension of a Model”, Annals of Statistics, 6, pp 461-464

26] Smirlock, M., L Starks, (1986), “Day of the week and intraday effects in stock returns”,

Journal of Financial Economics, 17, 197-210

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Introduction

Since the absence of a common meaning between producer and user may have damaging relevance consequences, the measurement of meaning is an important research area in accounting (Smith and Taffler, 1992a, p.84) To alleviate this potential problem, it has been argued that corporate reports should be communicated in such a way that makes them as readable as possible The SEC released an updated staff legal bulletin regarding plain English disclosures The plain English rule is designed to make prospectuses easier to read by requiring issuers to write in a clear and understandable manner (1999, p.69)

decision-Accounting research into the readability of annual reports was first published in 1952 Over the past 50 years annual reports readability has been investigated in the USA (Kinnersley and Fleischman, 2001; Pashalian and Crissy, 1952; Schroeder and Gibson, 1990; Smith and Smith, 1971), the UK (Jones, 1988; Smith and Taffler, 1992a, 1992b), Canada (Courtis, 1986, 1995), Australia (Lewis et al., 1986; Parker, 1982; Pound, 1980, 1981) and New zeland (Healy, 1997) Findings have consistently revealed annual report prose passages to be at a reading ease level of difficult to very difficult

The purpose of the present research is to extent the literature on this topic by examining the readability of the footnotes to financial statements in Kuwaiti corporate annual reports That is, the research is undertaken in an environment which differs from that in which previous readability studies were undertaken Thus, the findings of the present research are expected to contribute to the accounting research generally and to the accounting practice in Kuwait and other Middle Eastern countries in particular

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Organization of the Research

The next section reviews alternative measures of readability, and the prior research in the area of financial reporting This is followed by an explanation of the research methodology Next, the results are presented and discussed Finally the study concludes with a summary of the findings and their implications, together with directions for further research

Readability and its Measurement: Literature Review

Readability Measurement

Readability is generally considered to be one of the most important characteristics of effective reporting Alternative formulas have been adopted to measure readability Most of them attempt to assess the reading age required to understand a particular written passage, or a degree of difficulty associated with a particular level of education (Lewis et al., 1986, p 200) In assessing the reading difficulty, readability formulas concentrate on characteristics of writing style Generally, they are based

on two features: Word length - related to speed of recognition; and Sentence length - related to a recall

of words in the immediate memory (Smith & Taffler, 1992a, p 86)

A review of the literature reveals that, the most common readability formulas are Dale-Chall, Flesch, Fog, and Lix These formulas are described below with the aim of determining their relevance

to the measurement of readability of Kuwaiti corporate reports (Lewis et al., 1986; Smith & Taffler, 1992; and Stevens et al, 1992)

Dale-Chall

Dale-Chall Index = 15.79 (U/W) + 0.0496 (W/S)

Where: U = number of unfamiliar words, W = number of words and S = number of sentences The formula is based on an assumption that readability difficulty is a function of two factors: unfamiliar words and sentence length Therefore, the higher the score the more difficult the passage

Flesch

Flesch Index = 206.385 - (0.846 X L/100W) - (1 015 X W/S)

Where: L/100W = word length (number of syllables per 100 words) and (W/S) = sentence length (average number of words per sentence).The Flesch formula is simple to calculate The calculation represents a deduction from the base constant for both word and sentence complexity, so that the higher the score the easier the readability

Fog

Fog Index = 40 (P/W) + 0.4 (W/S)

Where: P/W = percentage of “hard” word in the passage and W/S = sentence length (average number

of words per sentence) The Fog formula is similar to the Flesch approach except that it is based on the percentage of polysyllabic words (i.e words of three or more syllables) in a passage The measure is therefore a function of sentence length and percentage of hard words The calculation is incremental with increased complexity so that the higher the score the more difficult the readability

Lix

Lix Index = 100 (B / W) + 1.0 (W / S)

Where: B/W = percentage of words of seven or more letters, and W/S = sentence length (average number of words per sentence) The aggregate score is compared with a scale of difficulty ranging from

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20 represents “very easy”, through stages to 60 representing “very difficult” (Lewis et al., 1986, p 207)

The Cloze Test

The above formulas highlight the importance of word and sentence factors to the measurement of readability The emphasis on words and sentences length, without reference to context, poses certain problems and limitations Several authors have argued that measures based upon word and sentence length may provide misleading results Lewis et al (1986, p 202) stated that, measures based upon word and sentence difficulty may be an oversimplification One or both of these variables may be unreliable as an indicator of readability That is, reducing sentence length will not necessarily improve readability Lesikar and Lyons (1986, p 151) highlight the use of the passive voice as a factor known to affect readability but argue that they are reflected in traditional formulae measures only to the extent of the longer sentence invariably generated

Moreover, these measures do not take account of the reader’s interest level Reading studies have clearly demonstrated that a high level of motivation towards the subject matter of the text has a markedly positive effect on the apparent reading competence of a poor reader Also, it is unlikely that these measures account for the impact of reading speed which is a function of time required to assess issues in the text, breadth of the reader’s previous knowledge and organization of material in the text being read (Lewis et al, 1986, p 202)

These problems and limitations suggest that words and sentences length are not the only variables affecting readability, and simplification alone does not automatically guarantee improved understandability Consequently, another measure is required Reading studies highlight the reliability

and usefulness of the Cloze Test in measuring readability It goes beyond word and sentence length to

reflect the interaction of several elements influencing readability Such elements as word meaning, language patterns, reader’s language ability and interests

The Cloze Test involves the mutilation of a narrative passage by the deletion of every nth word

and its replacement by a blank space Respondents are then required to predict the correct insertion for the blank based on the surrounding context (Smith & Taffler, 1992a, p 87) A readability measure is then derived by calculating the percentage of words correctly predicted by each respondent

The Cloze Test has been used to assess readability of accounting texts Steven et al (1983) used

it to measure the readability of Financial Accounting Standards Board Statement 33: “Financial Reporting and Change Prices” They emphasized the reliability of their procedure in comparison to those based on sentence and word difficulty Adelberg and Razek (1984) applied the Cloze procedure

to discriminate between accounting textbooks and recommended its further validation with accounting communications Several other studies, notably Smith & Taffler (1992a), emphasize the validity and reliability of the Cloze procedure

Litrature Review

Using one or more of the preceding measures, there have been several readability studies published in the accounting literature They covered most of the narrative disclosure areas They also examined trends in readability over time Generally, these studies concluded that corporate reporting was couched

in an academic, technical style that the unsophisticated reader would find difficult, or very difficult, to read and understand

Studies of footnotes to financial statements found that footnotes are difficult to read Smith and Smith (1971) found that less than 20 percent of the US adult population had achieved an educational level sufficient to comprehend the message appearing in 86 per cent of the notes to financial statements Healy (1977) examined the reading ease of footnotes contained within 50 New Zealand public corporations He found that the majority of footnotes to financial statements are of low

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readability, and this prevents many investors from gaining the information that may be necessary for rational economic decision making

Readability of other parts of annual reports was noted to be no better than readability of the footnotes Schroeder and Gibson (1990) in the USA found the level of readability of footnotes and management’s discussion and analysis to be similar, both significantly more difficult than that of the President’s Letter Still (1972) found that 77 per cent of a sample of 50 UK Chairman’s Statements required a level of reading ability which was beyond that of 80.7 per cent of US adults Pound (1981) also examined readability of the audit report, and concluded that audit reports require a level of education of at least university undergraduate in order to comprehend the messages contained in those reports

Studies of readability of annual reports over two or more periods found that corporate reports had become more difficult to read over time Lewis et al (1986) using a sample of Australian reports to employees, concluded that “reports to employees, while supposedly simplified for ease of lay reader understanding, were still pitched at a “difficult to read” level, and the readability of the reports did not appear to improve noticeably over time Jones (1988) examined the readability of the chairman’s narrative of a UK company from 1952 to 1985, and found that readability had declined significantly over this period

It is apparent that previous research has been undertaken in the English speaking countries The different language, legal, economic and social situations in these countries as compared to the Arab environments may impair the applicability of their findings to an Arab country This highlights the importance of and the need for the present research

Research Methodology

Choice of Readability Measurement

As mentioned above, alternative methods have been adopted to measure readability For the purpose of the present study, the Cloze Test was used The choice of this measure is conditioned by the limitations associated with other measures and its relevance and applicability to measure the readability of an Arabic text

The method of applying the Cloze test is defined as “a method of intercepting a message from a transmitter (writer or speaker), mutilating its language pattern by deleting parts, and so administering it

to receivers (readers or listeners) that their attempts to make patterns whole again potentially yield a

considerable number of Cloze units Thus, a close unit is any single occurrence of a successful attempt

to reproduce accurately a part deleted from a message by deciding, from the text that remains, what the missing part should be (Adelberg & Razek, 1984, p.111)

The Cloze test has several advantages over alternative techniques Among these advantages are: (1) Cloze tests are economical, easy to prepare, and easy to score They provide valid, reliable and easily interpretable results (2) Because Cloze tests are prepared entirely from a set of standard mechanical operations, they are not subject to conscious or unconscious biases of the investigator (3) Cloze tests measure the reader’s ability to predict the precise word used by the writer This ability is indicative of the reader’s understandability of the writer’s total meaning (Adelberg and Razek, 1984, p 115)

In measuring the readability of an Arabic text, the Cloze Test seems to be more applicable than those techniques based on word and sentence difficulty As an example, an accounting term like

“accounts receivable” can be written down in Arabic in several ways It can be written using a word of

5 letters or a word of 8 letters Although the two words have the same meaning, the latter would be considered as a hard word according to Lix formula Moreover, using number of syllables as a measure

of words length would be difficult in Arabic language due to the difficulty associated with the division

of words into syllables Moreover, calculation of number of syllables of an English texts can be easily

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undertaken due to the availability of microcomputer software packages, which is not the case with an Arabic texts

To support the results obtained by the Cloze Test, another test called reading Comprehension

test was used to measure the interaction between specific readers and specific messages This test is

assumed to determine the validity of the Close test as an instrument of readability measurement

Sampling Methodology

The Corporations Tested

Out of the annual reports of the corporations listed in the Kuwaiti Stock Exchange, two were selected given the relative importance of the Kuwaiti economic sectors As financial and real estate sectors dominate the economy, a bank and a real estate corporation were chosen: the National Bank of Kuwait (NBK) and Kuwait Real Estate Corporation (KREC) In terms of total assets, both NBK and KREC represent the largest corporation in their sector

It may be argued that the sample is small, and this would bias the results Choice of the small sample was due to the time factor associated with the application of the Cloze procedure Processing a passage of 300 words needs about 30 to 35 minutes Given that, any attempt to test more than two reports would be difficult and cause respondent fatigue Therefore, two reports were found to be relevant

The Massage Tested

Corporate annual reports consist of several parts (e.g financial statements, footnotes to the financial statements, auditor’s report, management’s discussion and analysis) Footnotes represent a large part of

a corporate report and crucial to understanding the figures in the balance sheet and the income statement Given that, footnotes to the financial statements of both NBK and KREC were selected for the purpose of readability measurement To facilitate the application of both the Cloze and Comprehension test, footnotes were produced in the form of paragraphs The resulting paragraphs were

retyped and mutilated so as to every fifth word was deleted and replaced by a dotted line (Adelberg and

Razek, 1984, p 113) The deletion commenced at the fifth word in the passage and continued at equal intervals throughout except for the incidence of proper name, dates and numbers, which are disregarded

Smith and Taffler (1992a) found that deletions in excess of 100 took too long to process and caused respondent fatigue Taylor (1956) has suggested that 50 deletions provide a sufficient sample for a stable and reliable score (see Adelberg and Razek, 1984, p 113) Miller and Coleman (1967) used

30 deletions in each of their validation studies (see Smith & Taffler, 1992a, p 88) In the present study

50 deletions were used in each passage To facilitate tabulating the results, each deleted word carried two marks (2 for correct and 0 for wrong) Thus, the maximum score that each subject could attain ranged between zero and 100 marks

Regarding the reading comprehension test 50 true-false questions were assigned on each passage Each question carried two marks (2 for correct and 0 for wrong) Thus, the maximum score that each subject could attain ranged between zero and 100 marks

The Subject Tested

Four hundred students from Kuwait University participated in the field work They were equally distributed over business and non-business colleges (i.e each group consists of 200 students) Students

in the two groups are in the third-year undergraduate study Students participating are assumed to represent different groups of users of corporate annual reports with different fields of education As compared to business students, non-business students are assumed to represent the ordinary users of annual reports

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Process of Data Collection

The Cloze and Comprehension tests were administered to business and non-business students, a test period being 60-75 minutes The administration process started with providing an idea of the importance of the readability of corporate reports This was followed by distribution of the passage with the Cloze test The test instructions were read to the participants as the participants read them silently The participants then recorded their responses directly in the spaces

Finally, the passage was distributed without any deletions The participants were given the time

to go through the passage and hand it back This was followed by distributing the reading comprehension test The participants then recorded their responses based on what they have understood during the process of reading the passage

This process was followed for each report (i.e the KREC’s report and the NBK’s report) and with each category of students During the administration process, efforts have been made to ensure that each participant worked individually and that external distractions were minimized

Research Hypotheses

The Cloze and Comprehension tests can be adapted to the study of any component of the accounting communication process (i.e financial report preparers, financial report message, or financial report user)

The present research used the Cloze test and Comprehension test to measure the readability of Kuwaiti corporate’ financial report messages, and whether the message readability level differed among report users depending on their educational background Given that, the following hypotheses were tested:

Hypothesis One (H 1 ): The Kuwaiti corporate annual report footnotes communicate at a level which is

not difficult to read and understand

Hypothesis Two (H 2 ): The level of readability of Kuwaiti corporate annual report footnotes does not

vary significantly among different groups of financial report users

Data Analysis and the Research Results

This section deals with analysis of the data and the results of testing the research hypotheses First, data and results related to annual report readability is presented (H1) This is followed by those data and results related to the potential difference between business and non-business students in understanding the Kuwaiti corporate annual report (H2)

Readability of Annual Reports (H 1 )

It has been agreed that a cloze score of 44 percent is comparable to a conventional multiple-choice comprehension test score of 75 percent (the instructional reading level- hereinafter referred to as the cut-off point) Thus, a cloze score of 44 percent can be considered to be a criterion level for instructional materials That is, if at least 44 percent of the deleted items are replaced correctly, the materials can be considered to be written at a level of understandability at or over the instructional level (Adelberg and Razek, 1984, p.114)

Following this criterion, student who scored the cut-off point and above presented an indicator

of reader’s understandability and readability of the given passage Given that, testing H1 was based on the following standards:

1 The average scores attained by students in each category (i.e business and non-business) as compared to the cut-off point indicated the difference between readability level of passage tested and the instructional reading level

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2 In evaluating the acceptance or rejection of H1, 2-tailed t-Tests were performed to test the significance of the difference between the observed mean readability scores of messages tested and the instructional reading level referred to above

Results of Applying the Cloze Test

Table 1 shows the observed mean scores and minimum and maximum scores attained by students through Cloze Test which was applied to the KREC's annual report It also displays coefficient of variation (CV) and t-Test results at 0.05 level of significance Table 2 presents the same information regarding the NBK's annual report

Figures in table 1 reflect substantial difference in the mean scores attained by business and business students As compared to the cut-off point of 44 percent, it is apparent that the observed mean scores attained by each group is below the cut-off point This is supported by the results of t-Test in which the observed mean scores and the established readability score (i.e 44%) differ significantly for both business and non-business students, as well as for the entire population

non-Results of applying the Cloze Test to the NBK’s annual report (Table 2) seem to be similar to those of the KREC The observed mean scores are less than the established readability score They differ significantly either for business or non-business students as well as for the entire population Apparently, some of the students in each group attained scores which are higher than the cut-off point

of 44 percent However, they represent a very low proportion of the sample As the Sign-Test results indicate (Table 5), 49 students out of 400 attained a score which was higher than the 44 percent

Table 1: Results of Cloze Test (Kuwait Real Estate Corporation)

Results of Applying Reading Comprehension Test

Tables 3 and 4 show the observed mean scores and minimum and maximum scores attained by students through a reading comprehension tests to the annual report of both KREC and NBK Tables also display coefficient of variation (CV) and t-Test results at 05 level of significance

The results presented in Tables 3 and 4 seem to be similar to those reported in Tables 1 and 2 They indicate that the observed mean scores attained by students and the cut-off point of 75 percent differ significantly at a 0.05 level of significance This was the case in all situations, i.e., whatever the group tested (business or non-business) or the report tested (KREC’s report or NBK’s report)

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Table 3: Results of Reading Comprehension Test (Kuwait Real Estate Corporation)

Based on the results of applying both the Cloze and Comprehension tests, it seems reasonable to

reject H1 and conclude that footnotes to the financial statements of Kuwaiti corporations are written and

communicated at a level and in a style which is difficult to read and understand

Two other aspects can be observed from the results reported in Tables 1, 2, 3 and 4:

a The readability level of the annual report of both KREC and NBK is relatively similar That is,

there is no substantial difference between the observed mean scores for the two reports This

can be easily noticed when results reported in table 1 are compared to those reported in Table 2,

and the results reported in Table 3 are compared to those reported in Table 4

b The mean scores reported as a result of applying the reading comprehension test (Tables 3 and

4) are higher than those resulting from the application of the Cloze test (Tables 1 and 2) This

may be due to the methodology of applying the two tests That is, application of a

comprehension test requires students to read the text before answering the test questions With

the Cloze test, however, students are required to predict the correct deleted words without

having been given the chance to become familiar with the report

Table 5: Results of sign-test

Cloze Test

Business Students

Non-Business Students

Comprehension Test

Business Students

Non- Business Students

* LT = number of cases with score less than the readability criterion level

**GT = number of cases with score greater than the readability criterion level

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Educational Background and the Readability of Reports (H 2 )

If we agree that footnotes within corporate annual report is difficult to read and understand, the question is whether this degree of difficulty differs significantly among the report’s users depending upon their educational level or background The second hypothesis of the research (H2) deals with this, namely the level of readability of Kuwaiti corporate annual report footnotes does not vary significantly among different groups of financial report users

For the purpose of testing this hypothesis, data were analyzed on the basis of the following standards:

a the average scores attained by the students of each group (business and non-business) in each report (KREC and NBK) indicated the difference between the readability level of the two groups (Tables 1, 2, 3 and 4 summarize the results)

b In evaluating the acceptance or rejection of H2, 2-tailed t-Tests were performed to test the significance of the difference between the mean scores attained by business and non-business students for each report (Table 6 shows the results)

Figures in Tables 1, 2, 3 and 4 reflect substantial differences in the mean scores attained by business and non-business students Clearly, the mean scores of business students are higher than that

of non-business students This was the case in all situations, i.e whatever the report tested (KREC or NBK) or the test applied (Cloze or Comprehension test)

The results of applying the Cloze Test to the KREC’s annual report (Table 1) indicate that the maximum score of 58 was attained by business students, while the maximum score attained by non-business students was 50 Also, there is a difference of 13 points between the mean score attained by the two groups Similar results were reported regarding the NBK’s annual report (Table 2) The Sign-Test results (Table 5) show that while 24% of business students attained a score greater than the criterion level, only 0.5% of non-business students have attained similar score

The results of applying the Comprehension test (Tables 3 and 4) seem to be similar to those reported through the Cloze test That is, the observed mean scores attained by business students are higher than those attained by non-business students As can be noticed form Table 4, while the minimum score attained by business students was 48%, the minimum score attained by non-business students was only 36%

The Sign-Test results (Table 5) indicate that only 9% of non-business students achieved a score greater than the instructional reading level, while more than 20% of business students achieved a similar score However, it should be noticed that both are very low percentages

Table 6 shows results of testing the relationship between the scores attained by business and non-business students It also reports correlation coefficient and T-Test results

Table 6: Readability and Educational Background (Results of T-Test)

Cloze Test

Comprehension Test

A correlation coefficient was determined to give an indication of strength in the linear relationship between the two scores As Table 6 shows, a negative relationship was reported regarding the National Bank of Kuwait annual report when applying the Comprehension Test In the other three situations (i.e., results of applying the comprehension test to the KREC annual report and applying the

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Cloze Test to both KREC and NBK annual reports), a very low positive relationship was reported with

a maximum value of 0.09 This is supported by the t-Test results which indicate that scores attained by both business and non-business students differ significantly in all situations, i.e., whatever the report tested (KREC or NBK report) or the test applied (Cloze or Comprehension test)

Based on the results of applying both the Cloze and Comprehension tests, it seems reasonable to reject H2 and conclude that there is a highly significant difference between business and non-business students in their ability to read and understand the footnotes of Kuwaiti corporate annual reports

Summary and Conclusions

This study has examined the readability of the footnotes to the financial statements of two Kuwaiti corporations listed in the Kuwaiti Stock Exchange The objective has been to test the readability of the Kuwaiti Corporate annual report footnotes and whether their readability levels differ significantly among user groups according to their educational background

Two hypotheses (H1 & H2) were tested using data gathered through both the Cloze and reading comprehension techniques The data have been gathered from third-year undergraduate students representing both business and non-business

The results indicate the rejection of H1 Footnotes to the financial statements of Kuwaiti corporations are written and communicated at a level and in a style which is difficult to read and understand The results show a 12% of business students reached the required score target The results also indicated the rejection of H2 Readability levels of footnotes of Kuwaiti corporate annual reports vary significantly among different groups of financial report users The mean scores attained by business students were significantly higher than those attained by non-business students However, both are below the required mean score target

The findings of the present study are in line with the studies undertaken in western countries which reported that annual reports are difficult for most users to understand The findings of the present study and those of the previous studies indicate that despite the importance of preparing the annual reports in a language that can be understood by readers, the preparers of these reports show little effort

in this regard

These results encourage more attention to improve the communicative ability of the corporate annual reports Accordingly, preparers of Kuwaiti corporate annual reports should take into account the readers’ ability to understand the meaning of symbols and expressions used in these reports They should try to use a language that is easy to understand by ordinary users They may also consider using additional methods of communicating their intended message, such as graphs and visual methods This remains an area for further research in which these methods would be examined as to whether they improve the communication function of corporate annual reports

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corporate reports of a UK company”, Accounting and Business Research, Vol 18 No 72, Autumn 1988, pp 297-305

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pp 775-779

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performance', Accounting and Finance, November 1992, pp.75-90

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European Journal of Economics, Finance and Administrative Sciences

The purpose of this paper is to apply some of the major OCA criteria to Egypt to determine

whether it is a good candidate for a fixed exchange rate regime or not The OCA criteria used include price and wage flexibility, factor mobility, trade openness, the size of the economy, and currency substitutability Egypt is a large economy as its population was 66.4

millions in 2002 Its trade is modest since its exports and imports form a low percentage of

GDP compared to other open economies such as Hong Kong Egypt is not considered a diversified economy and does not have a particular foreign currency that substitutes the national currency in domestic transactions The Egyptian pound is the only currency that is

accepted as the exchange money in daily life Egypt’s prices and wages are somewhat inflexible compared to the relatively highly flexible and rotating labor market in the United

States Hence, based on this study, Egypt may be a good candidate for flexible rather than fixed exchange rate regime The main reasons are that Egypt is a large closed economy, its

trade pattern isn’t diversified, its labor mobility is rather low, and its prices and wages aren’t very flexible

Keywords: Egypt, Exchange Rate, OCA

Introduction

Traditional analysis of Optimum Currency Area (OCA) has been conceived in terms of balancing the micro benefits to be gained through currency unification or fixed exchange rates against the macroeconomic costs of giving up the exchange rate as an instrument of balance of payments adjustment In modern literature this consideration is usually discussed within the context of whether changes in nominal exchange rates can have more than transitory imoacts on real exchange rates (Willett, 99)

There are nine characteristics identified by Tavlas to become a participant in an OCA, namely: (1) similarity of inflation rates; (2) the degree of factor mobility; (3) the openness and the size of the economy; (4) the degree of the commodity diversification; (5) price and wage flexibility; (6) the degree

of goods market integration; (7) fiscal integration; (8) the need for real exchange rate variability; and (9) political factors (Willett, 99)

Recent surveys by Bofinger (94), Masson and Taylor (93,94), Talvas (93, 94) and Whilborg and Willett (91) added to the list of considerations factors such as optimal public finance, the degree of

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international currency substitution, the new classical view of policy ineffectiveness, the price and quality signals from the money and financial markets, controllability of the money supply, time inconsistency problems, credibility and the use of institutional arrangements to affect national monetary and fiscal policies (Willett, 99)

The purpose of this paper is to some of the major apply OCA criteria to Egypt These include, price and wage flexibility, factor mobility, trade openness and the size of the economy, currency substitutability, pattern of shocks, and trade diversification The first and the second factors are related

to the cost of abandoning the national monetary policy If a country is facing the imbalance payment (surplus/deficit) it needs to deal with costs of adjustments If this is a temporary phenomenon, we could use financing instead of adjusting the exchange rate But if it is a fundamental problem, we need to adjust the exchange rate; otherwise it will raise the dilemma problem The paper is divided into three sections The first section is the introduction that includes a description of the evolution of the exchange rate regime in Egypt The second section is an application of the major OCA criteria to Egypt The third part is the conclusion

Egypt (An Overview)

Egypt is a large economy as its population was about 66.4 millions in 2002 As for its exchange rate policy, Egypt has followed a fixed adjustable peg policy against the US dollar Egypt tried to affect both the supply and demand for foreign exchange since 1969 via using different premiums on the official exchange rate On September 1, 1973 an official parallel market was established to replace all premiums and surcharges The exchange rates in the parallel market, which remained almost stable in 74-75, were established at a premium over the official rate

By the end of 1976, the foreign exchange market was divided into the central bank rate dealing with its transactions, the commercial bank rate for controlling the transactions of the public sector companies and the free market rate for the private sector transactions

In the early 1980s, the three rates of foreign exchange continued to exist In February 1991, the old multiple fixed parity exchange system was replaced by a dual flexible peg exchange rate regime for

a short period of time In October 1991, the foreign exchange markets were unified (Kheir El Din, & El Shawarby, 99)

Pegging the exchange rate caused a large decrease in Egypt’s international reserve, increased people’s expectations for a devaluation, and led to a rise in the demand of US dollars Consequently, the government followed a crawling or adjustable peg system in 2001 and the Egyptian pound devalued further to LE 4.5/$ In January 2003, the exchange rate became flexible causing the Egyptian pound per dollar devalued further to 6 pounds per dollar in 2003

Application of OCA Criteria to Egypt

Size and Openness

Egypt is a large economy as its population was about 66.4 millions in 2002, as per the following table

Table 1: Egypt population and GNI in 2002

2002 Egypt

Population, mid year (in millions) 66.4

Source: Based on the World Bank Group: http://www.worldbank.org/data/- Retrieved on Feb 2004

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Hence, given the size of the country and the population, Egypt cannot be included in a small

country group With regard to the degree of openness, open economies tend to be the smallest and

exhibit the largest propensity to import If an economy is open in terms of traded goods portion to the

economy, the fluctuation in exchange rate will harm the economy through higher cost This country

will be better off with fixed exchange rate, which will go further to fix the price level Besides, the

country with high marginal propensity to import is also preferable to have fixed or pegged exchange

rate system The following table illustrates Egypt’s import and export as a % of GDP

Table 2: Egypt’s Exports and Imports/GDP in 1992, 2002 and 2002

Source: The World Bank Group, 2004

According to table 2, Egypt cannot be considered an open economy since its exports as a % of

GDP were only 17.4% and 18.2% in 2001, and 2002 respectively Similarly, its imports form a

relatively low level of GDP, compared to other open economies such as Hong Kong, ranging from

31.8% in 1992, to 22.1% in 2001, and 22.7% in 2002 Based on the above, Egypt’s trade can be

considered modest

This result can also be supported by the following graph that illustrates Egypt’s exports of

goods and services as a % of GDP from 1994 till 2000

Table 3: Egypt’s import and exports of goods and services as a % of GDP

Gross Domestic Product (GDP) (In LE billions)

Exports of Goods&

Services/GDP

Imports of Goods&

Source: Based on IFS- CD, April 2003

The table illustrates that Egypt’s exports and imports of goods and services formed a relatively

low percentage of GDP compared to open economies, reaching on average about 19%, and 26.11%

respectively from 1994 till 2000

According to table 4, the European Union (EU) countries are Egypt’s main trading partners In

the first two years of ERSAP (90/91 and 91/92) with the pound pegged to the dollar, Egypt’s exports to

the EU averaged 34% of its total exports and imports from the EU averaged 31% of Egypt’s total

imports Egypt’s exports to the US in those two years averaged 12% of total exports and its imports

averaged 16% of total While the US ranks first for Egypt for the years 1999 till 2001, the EU countries

rank first for imports for the same period Hence, the US is not Egypt’s main trade partner, and in 93/94

and in 94/95 the relative ranking of EU countries and the US did not change

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Table 4: Egypt’s proceeds of exports and imports from 1999-2001

Other African countries 37.3 41.1 118.8 124.5 -81.5 -83.4

Other Asian countries 917.9 765.9 2956.1 2553.8 -2038.2 -1787.9

Source: Central bank of Egypt Annual Report

Since Egypt is large and closed economy, based on the size of its population, and exports and

imports as a % of GDP, as illustrated before, it is more advisable that it follows a flexible exchange rate

regime based on this criterion

2 Degree of Diversification

According to Kenen (1969), a diversified economy is a better candidate for a fixed exchange rate The

reason is that if a country has diversified exports, its economy can be protected from external shocks,

its capital formation can be stabilized; hence, the burden placed on the internal policies can be

decreased A type of diversification can focus on the structure of the Egyptian economy that can be

illustrated in the following table

Table 5: Relative importance of Sectors as a % of GDP (Value at prices of base year 1996/97)

1998/1999 99/2000 2000/2001 Value

(LE bn) Importance Relative (LE bn) Value Importance Relative (LE bn) Value Importance Relative

Commodity Sector of which: 133.1 49.6 140.0 49.6 147.3 49.7

Personal & community services 20.9 7.8 21.7 7.7 22.6 7.7

Source: entral bank of Egypt Annual Report, 2000/2001

According to this table, Egypt cannot really be considered a diversified economy as the shares

of the commodity sectors were about 49.6% of GDP in 2000/2001, followed by the productive and

service sectors that constituted about 32.7%, and 17.7% of Egypt’s GDP during the same period

(Central bank of Egypt Annual Report, 2000/2001)

Another type of diversification emphasizes the trade share of Egypt’s export and imports

partners as shown by the following table that illustrates the relative importance of the geographical

distribution of commodity transactions (%) from 99/2000-2000/01

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Table 6: eographic Distribution of Egypt’s Exports and Imports during 99 till 2001

99/2000 2000/2001 99/2000 2000/2001

Source: entral bank of Egypt Annual Report 2000/01

According to table 6, Egypt’s main exporter is the USA as it formed about US$ 2.9 billion or

40.8% of Egypt’s total exports in 2000/01 EU came second in importance as it constituted US$ 2

billion or 28.4% of Egypt’s total exports during the same period As for the Arab countries, they

formed about US$ 816.7 million or 11.5% of Egypt’s total exports followed by the Asian countries that

constituted about US$ 765.9 million or 10.8% of Egypt’s total export proceeds during the same period;

where India held the top position, followed by Singapore, Japan, Hong Kong, South Korea, and China

The share of other European countries was only US$ 322.8 million or 4.6% of Egypt’s total export

(Central Bank of Egypt Annual report 2000/01)

With regard to Egypt’s imports, the EU is its major importer as it formed about US$ 6.1 billion

or 37.4% of its total imports Germany came first, followed by UK, France, and Italy While USA is

Egypt’s main exporter, it held a second position in the relative importance of Egypt’s imports reaching

26.9% The Asian countries ranked third in their relative importance with US$ 2.6 billion or 15.5% of

Egypt’s total imports; where, Japan came first, followed by China, South Korea, India and Hong Kong

The relative importance of other European countries was small as it formed US$ 1.3 billion or 7.7% of

total imports Switzerland came first followed by Turkey and Romania Regarding imports from Arab

countries, they reached US$ 753 million or 4.6% of total imports Saudi Arabia came first, followed by

UAE, and Kuwait (Central Bank of Egypt Annual report 2000/01) A third type of diversification

emphasizes Egypt’s composition of traded goods and services as shown in the following tables

Table 7: Distribution of Commodity (exports) in US$ MN

1999/2000 2000/2001 Value % Value %

Source: Central Bank of Egypt Annual Report 2000/2001

Egypt’s export reached US$ 690.5 million during 2000/01 This was mainly attributed to a rise

in crude oil and its products, and non-oil exports; especially, finished products such as iron and steel

products, sugar , rice and cotton textiles that increased in 2000/ 2001 by US$ 184.7 million or 7.1% to

reach US$ 32.8 billion As for the semi finished products, they increased by 40.9%; while, raw

materials rose by only 5.8%

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Table 8: Composition of Imports (US$ MN)

1999/2000 2000/2001 Value % Value %

Source: Central Bank of Egypt Annual Report 2000/2001

According to this table, Egypt’s main imports are raw materials, intermediate and investment

goods as they formed about 22.4%, 24.2%, and 22.5% respectively of Egypt’s total imports in 2000/01

Commodity import decreased by US$ 1.4 billion or 8% to US$ 16.4 billion in 2000/2001 due to a

decrease in all import products with the exception of raw materials that rose by US$ 991.0 million to

reach US$ 3.7 billion, due to a rise in crude oil and wheat

The following table also illustrates Egypt’s composition of trade in 2002

Table 9: Egypt’s trade composition in 2002

Source: Ministry of Foreign Trade, Monthly Economic Digest, May 2004

The table supports the previous results that Egypt’s main exports are fuel as it represents 39.9%

of its total exports; while, Egypt’s main imports are the intermediate products (38.7%) followed by raw

materials (13.7%) Hence, based on the above analysis regarding the diversification criterion, Egypt

cannot be a good candidate for a fixed exchange rate

3 Prices and Wages

Pegging the Egyptian pound to the US dollar has helped to keep inflation low during the mid 90’s and

till 2002 It reached 2.4% during 2000/2001 based on CPI yearly average, compared to 2.8% in

Source: Based on the Central Bank of Egypt Annual Report- 1998/99 & 2000/2001

Similarly, according to this table, Egypt’s inflation rate (based on the annual average) decreased

from 4.3% in 1998/98 to 3.7%, 2.8% and 2.4% in 98, 99, and 2000 respectively This result is also

supported from the following table and graph that shows Egypt’s CPI from 1993-2002

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Table 11: Egypt’s CPI from 1994- 2001

Source: Based on the IFS- CD Rom April 2003

Chart 1: Egypt’s CPI from 1994-2001

Source: Based on the IFS- CD Rom, April 2003

Pegging the Egyptian pound has also helped to maintain the inflation rate stable during the mid

1990s and up till 2001 as show from the previous chart However, the devaluation of the Egyptian

pound as a result of floating the exchange rate led to an increase in the inflation rate to 4.7% and 5.2%

in September and October 2003 respectively

Egypt’s trade partners’ inflation rate ranged between 1.6% and 4.55% with a weighted average

of 2.73% during 2000/2001, compared to 2.78% in the previous FY as will be illustrated in the

following table

Table 12: Inflation in Egypt’s Trade partners

Relative weight of external trade based on volume Inflation Rates % 1999/2000 Inflation Rates % 2000/2001

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Regarding Egypt’s real wages, it decreased in the late 80’s and 90’s after being increased between the mid 1970s and the mid 1980s Besides, real wages in the mid 1990s reached about two-thirds of their level in the mid 1980s Data and information regarding trends and wage differentials in Egypt aren’t usually available However, many factors have impacted the competitive wage-setting in Egypt Although the government no longer guarantees providing employment for graduates in the public sector in the early 1980s, the government still plays a crucial role in controlling wages Another crucial employment channel is through networking

In general, flexible wages and prices entail a smaller macroeconomic adjustment cost to a fixed exchange rate Based on analysis presented regarding Egypt’s inflation rate, it can be concluded that its prices are somewhat inflexible Similarly, wages in Egypt aren’t very flexible For example, the Egyptian workers tend to have life time jobs compared to the relatively highly flexible and rotating labor market in the United States This illustrates lesser flexibility in Egypt for wages compared to the Unites States Hence, based on this criterion, it is costly for Egypt to maintain a fixed exchange rate

5 Currency Substitution

The substitutability criterion means that there is (are) foreign currency (ies) acceptance in domestic transactions Because of the acceptance, the currency substitution can affect the variability of domestic demand for money Thus, a country with high degree of currency substitutability is suitable to peg its exchange rate to that particular foreign currency The transaction cost and the uncertainty will be eliminated with fixing or pegging the exchange rate To adopt a flexible exchange rate is not favorable because it will be unstable Currency substitution tends to strengthen the case for fixing the exchange rate

Egypt does not have a particular foreign currency that substitutes the national currency in domestic transactions The Egyptian pound is the only currency that is well spread accepted and known

as the exchange money in daily life Therefore, this criterion points out that Egypt is not suitable to peg its exchange rate

III Conclusion

By applying the OCA criteria to Egypt, one can conclude that Egypt may not be a good candidate for fixed exchange rate, but rather a good candidate for a flexible exchange rate The reasons are the following First, Egypt is a large a closed economy Its trade as a percentage of GDP is low Second, its trade pattern isn’t diversified as its exports and imports are concentrated in few key commodities as illustrated before Third, its labor mobility is low Regarding, its wage rigidity, while the data aren’t robust enough, preliminary statistics revealed that real wages are decreasing In other words, nominal wages aren’t increasing fast enough to accommodate for the increase in inflation Also, compared to some other countries (i.e the United States), Egypt’s prices and wages are less flexible Finally, most

of the major OCA criteria support the argument that Egypt can be a good candidate for a flexible rather than fixed exchange rate

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References

1] Domac, Iker and Shabsigh, Ghiath (1999) “Real Exchange Rate Behavior and Economic

Growth: Evidence from Egypt, Jordan, Morocco and Tunisia” International Monetary Fund

Working Paper No 99/40 (March, 99)

2] Eichengreen,B (1998) “Does Mercosur Need a Single currency?” Paper No C 98/103 Center

for International and Development Economics Research, Institute of Business and Economic

Research Berkley: University of California, Berkeley

3] Eichengreen, B and C Arteta (2000) “Banking Crises in Emerging Markets: Presumptions and

Evidence” Paper No C00-115.Center for International and Development Economics Research

Institute of Business and Economic Research, University of California, Berkeley

4] Fischer, Stanley (2001) “Exchange Rate Regimes: Is the bipolar View Correct?” Finance &

Development A Quarterly Magazine of the IMF: June 2001, volume 38, No.2

5] Galal, A (2003) “To Float or Not Float: That is No Longer the Question for Egypt.” ECES

Policy Viewpoint No 13

6] Hill, Jonathan 2003 “Country Risk Analysis: Egypt” The PNC Financial service Group http://

www.econ.pncbank.com/Egypt.hym Retrieved on April 2004

7] Jbili, Adelali, and Kramarenko, Vitali (2003) “Choosing Exchange Regimes in the Middle East

and North Africa” IMF, 2003

<http://www.imf.org/external/pubs/ft/med/2003/eng/jbili/jbili.htm>

8] Kamar, Bassem, and Damyana Bakardzhieva (2003) “Economic Trilemma and Exchange Rate

Management in Egypt” Conference of the Economic Research Forum for the Arab Countries,

Iran, and Turkey December 16th-18th, 2003 Marrakesh, Morocco

9] Korayem, Karima (1997) “Egypt’s Economic Reform and structural Adjustment (ERSAP)”

The Egyptian Center for Economic Studies Working paper no 19

10] Kheir El din, Hanaa, and El Shawarby, Sherine (1999) “Trade and foreign Exchange Regime in

Egypt” Cairo University Research Undertaken for the Premise Research Project: FEM-

ERF/99/B101

11] Leblang, David (2001a) “ The political Economy of Speculative Attacks in the Developing

World,” Manuscript, Department of political science, University of Colorado

12] Maskay, Nephil(1998) “Monetary and Exchange Rate Policy for Small Developing Countries:

A case Study of Nepal” Ph.D Dissertation Claremont: Claremont Graduate University

13] Mongardini, Joannes (1998) “Estimating Egypt’s Equilibrium Real Exchange Rate”

International Monetary Fund: Working Paper No 98/5

14] Nitithanprapas and Thomas Willett (2000) “A currency crisis Model that works: A Payments

Disequilibrium Approach” Claremont Working Paper no 2000-25 Claremont: Claremont

Graduate University

15] Nitithanprapas, Isriya and Rogola, Sunil and Willett, Thomas (2002) “ The Role of Capital

Controls and Currency Regimes in the Asian Crisis” Claremont Working Paper N Claremont:

Claremont Graduate University

16] Rizk, Nagla “ Technology for Egypt’s Regional & Global Integration The American

University in Cairo http://www.luc.edu/orgs/meea/volume3/nagla.htm Retrieved on April

2004

17] -US Department of State.2000 Country Reports on Economic Policy and Trade

practices: Bureau of Economic and Business affairs US Department of State, March 2001

<http://www.state.gov/documents/organization/1638.pdf> Retrieved on Feb, 2004

18] Willett, Thomas and Nitithanprapas (2002) “Classifying Exchange Rate Regimes” Claremont

Working Paper WP no 22 Claremont: Claremont Graduate University

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19] Willett, Thomas (1999) “The OCA Approach to Exchange Rate Regimes: A Perspective on

Recent Developments” Prepared for conference on “Should Canada and the US Adopt a

Trang 39

European Journal of Economics, Finance and Administrative Sciences

M Phil Student at Applied Economics Research Centre

University of Karachi, Karachi

trade openness works as safety valve in the case of small developing economy like

Pakistan

Keywords: Openness, Inflation, ARDL Co-integration

Jel Classification Codes: F10, O53, C22

I Introduction

Inflation has comprehensible costs to an economic and social system A high rate of inflation could lead to widespread resources being exhausted in inefficient transactions and speculation, and it destroys the basis for rational economic decision and reparation the trustworthiness of most of the governmental policies Standard open economic models forecast that, openness to trade should exert a positive effect

on the slope of the output-inflation tradeoff, or Phillips Curve, but such a proposal finds very little hold

up in the existing empirical literature Gupta, (2003); in the 1990s one of the main concerns of governments all over the world has been that of controlling inflation This is evident in the global trend

of disinflation in the 1990s.In some of the Latin American countries, inflation go down from over 400% in 1990 to under 10% in 1999 This period also witnessed a significant expansion of the world trade organization (WTO) Merchandise and commercial services trade witnessed an average annual

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growth of 6% over the 1990s Despite the fact that, pertinent existing literature do not have an accord inspection on the subject of relationship between openness and inflation, mostly consisted on cross-sectional results

Fischer (1993) supported the argument that, stable macroeconomic policies, as the economies open up, the fiscal and monetary establishment tends to lose their capability to control inflation through fiscal and monetary policies Cook (2004) concluded that openness and inflation have the standard negative relationship, holding consumption constant However, consumption depends on foreign demand; an increase in foreign demand therefore creates a large enticement for the monetary authority

to pump up This incentive disappear when the economy is closed so that if foreign demand is sufficiently high when the economy is open but may as the economy become more closed Openness has an inverse relationship with inflation when foreign demand is low but not exact when foreign demand is high The standard openness-inflation result is inverted; inflation may rise and fall as the country become more open (Cook, 2004)

Earliest works in this region was Triffin and Grubel (1962) in open economy the direct impact

of the excess demand on the balance of payments without dirge for the indirect balance of payment decline resulting from a rise in price level They looked into the economic performance of 5 countries (France, Italy, Germany, Netherlands and Belgium-Luxembourg) and found that more open economies practiced lower inflation Their consequences were that openness proved as a safety valve and the domestic inflationary pressure spilled over into the Balance of payments (BoPs) in the open economy Iyoha (1973) analyzed the relationship between Inflation and openness in a bivariate framework He reported a negative relationship between openness and inflation Kirkpatrick and Nixon (1977) in their comment on the paper by Iyoha (1973) argued that cut down of imports could make worse the inflationary situation The argued that composition of imports needs to be examined to cheek the inflation and openness link and more reliable indicators of openness are needed for a through understanding of the issues occupied Temple (2002) concluded that, openness exerts no systematic effect on the slope of the Philips Curve

Openness-Inflation Puzzle

The openness inflation trade-off association appears to have strengthened during the 1990 and is more significant than earlier research suggested-extending even to the OECD countries Yet, the origin of this relationship remains something of a puzzle Romer (1993) and Terra’s (1998) findings in more general dynamics results suggesting that, a negative openness-inflation relationship strengthening across all group countries And divergent to Terra,s (1998) hypothesis, except during 1980s, the openness-inflation nexus is more significant among less indebted countries In the regard of Romer, Lane (1997) Point out that, domestic expansion leads depreciation through its affect on world prices The assumption of Romer’s model leads to depreciation is unsatisfactory or ambiguous results (Puzzle) Lane analyzed the welfare effect of a monetary According to the ‘new growth theory’, openness is likely to effect inflation through its positive influence on the output, which is likely to improve the pressure on the price1 In the open economy the shocks to the price level due to the domestic farm sector output fluctuation are likely to ease, when the volume of openness increase to diminish the price fluctuation in open economies 2 (Jin, 2000).Temple (2002) as the degree of openness raises the Phillips curve trade-off becomes less favorable and optimal policy is less expansionary This mechanism generates an inverse relationship between openness and inflation3 Nominal rigidities, unanticipated monetary in small open economies leads to real currency depreciation, the depreciation in real terms will raise the price of the imported goods Inflation will also increase if we measured inflation in terms of consumer price index But on the other hand if wages are indexed to the consumer

1 This link is going to work though the channel of reduces quantitative restriction, which is the quantity link impact

2 To see (Sanyal, 1996; Okun, 1981; Kaleeki, 1972)

3 Empirical investigation based on this idea, which has been carried out by Romer (1993), Lane (1997).

Tiêu đề	European Journal of Economics, Finance and Administrative Sciences - Issue 8 (2007)
Người hướng dẫn	Adrian M. Steinberg, Editor-In-Chief
Trường học	University of Baltimore
Chuyên ngành	Economics, Finance, Administrative Sciences
Thể loại	Journal Issue
Năm xuất bản	2007
Thành phố	Unknown

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Số trang	139
Dung lượng	0,99 MB