what is emerging market

Global Capital Market – Lecture 1W Capital Market Theories Emerging Market Finance CAU MBA CAU Bruce Wonil Lee, Ph.D, & CFA What is Emerging Market?. Milestones in the Development of

Global Capital Market – Lecture 1W

Capital Market Theories

Emerging Market Finance CAU MBA

CAU

Bruce Wonil Lee, Ph.D, & CFA

What is Emerging Market?

March, 2015

What defines an Emerging Market?

countries” which were not emerged yet

currency markets and sometimes even not industrialized

economically but markets are remaining infancy

Indonesia, etc are generally considered as EM

Effect”

EM have been major source of global growth

Japan in 1960-80s, China in 2000, etc

supply and tends to have less debt compared with developed markets

commodities for developed markets

long term

EM tends to have economic crisis

50 years

Philippines, even Korea in 1997 So called Asian Currency Crisis

Bulgaria, Poland, Russia, etc

Honduras, etc

default risk issues, and spilled over contagion effects, etc

Frontier Emerging (Pre-emerging) Markets

are defined as Frontier Emerging Markets

with investable stock markets that are less established than those in emerging markets

inadequate regulation, substandard financial reporting and large

currency fluctuations

etc

Multi-national Companies and EM

frontier EM for growth potential

tends to invest EM

higher return with better diversified risk

– inadequate market data, lack of information, poor visibility on

regulatory environment, political uncertainty, lack of reliable market research, language and cultural differences, etc

Capital Market Theories

1964, CAPM

Asian Currency

Crisis

2002, Nasdaq Bubble

1987 , Black Monday

1962, DDM

1973, Black &

Scholes Model

2007, US Sub Prime

Equilibrium Price (Force of Demand = Force of Supply)

Equilibrium Quantity

Equilibrium

Price

P1

P2

Excess supply

Excess demand Price

Quantity

Milestones in the Development of Portfolio and Capital Market Theory

 Portfolio Theory

– Markowitz, Harry (1959): Portfolio Selection - Efficient Diversification of Investments, New York, John Wiley & Sons

 Capital Asset Pricing Model

– Sharpe, William F (1964): Capital Asset Prices: A Theory of Market Equilibrium Under Conditions

of Risk, Journal of Finance 19, September

 Efficient Market Hypothesis

– Fama, Eugene (1970): Efficient Capital Market, Journal of Finance 25, May 1970

 Arbitrage Pricing Theory

– Ross, Stephen (1976): The Arbitrage Theory of Capital Asset Pricing, Journal of Economic

Theory 13, December

 Option Pricing Model

– Ross, Stephen and Mark Rubinstein (1979): Option Pricing: A Simplified Approach, Journal of Financial Economics, September

Step of Investment Decision

Result: group of dots

Risk E(σp) Expected rate of return

E(Rp)

The Efficient Frontier

The EFFICIENT FRONTIER represents that set

of portfolios that has the maximum rate of return for every given level of risk, or the maximum risk for every given level of return

Risk E(σp) Expected rate of return

E(Rp)

CAPM: Capital Asset Pricing Model

Expected rate of return

E(Rp)

Risk E(σp) Risk Free Rate

M (Ideal portfolio)

Implication of CAPM

 The Equation:

E(R i )= R f + βi {E(R m )-R f }

 CAPM emphasizes the only one risk factor (the market risk)

 The market portfolio plays a central role

 CAPM holds for all individual securities and all portfolios

β is the Key Factor

of CAPM!!!

If we can find out how risky an asset is, it would be possible to find whether the

asset is overpriced or under priced => CML!!!

CML : The Capital Market Line

Expected rate of return

E(Rp)

Risk E(σp)

Risk-free rate of return

A

B

Under priced

Over priced

 APT model can have multiple sources of risk

 The APT does not tell what the risk factors are, so we are forced to choose those economic factors that we think might be important

 APT holds for all diversified portfolios and should hold for most individual securities

APM : Arbitrage Pricing Model

CAPM assumed that there is only one risk factor; the Market Risk Is it possible?

The Equation:

E(R i )= R f + βi {E(Rm)-R f }

E(R i )= R f + β F1 {E(R F1 )-R f } + β F2 {E(R F2 )-R f } + … + + β FK {E(R KF )-R f }

The Market Risk is just one of them we can imagine There are more!

 Assumption: Underlying security prices can only either increase or decrease with time until the option expires worthless

 Three steps for Option Valuation:

1) price tree generation

2) calculation of option value at each final node

3) progressive calculation option value at each earlier node; the value at the first node is the value of the option

Binominal OPM; Option Pricing Model

S

S up =S·u

S down =S·d

U ≥ 1 and 0 < d ≤ 1

(After one period of time)

The Gap between Theories and Practices

 Global Capital Market has more than 200 years of history but theories were at most 60 years old

 These theories are based on developed markets which often cannot explain emerging markets

 Practices in the market cannot be fully explained by the theories which are only tools to help our understanding what is happening the actual Market

 Contemporary issues in the recent Global Capital Market cannot be fully explained by the Theories – Private Equity Fund: Lone Star, KKR, Blackstone, etc

– Hedge Fund: Millennium, Farallon Capital, Cerberus Capital, etc

– Shareholder Activism, Corporate Governance: CaLPERs, Karl Ichan, etc

– Sovereign Fund: GIC, KIC, Dubai Gov, etc

– Pension Fund

– Emerging markets

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