| Understanding the risk and reward from investing in emerging equity markets is necessary for rational flows of equity financing to developing countries. Early research claimed that investing in emerging markets significantly improved the performance of global stock portfolios, but this may have been due to misinterpretations of the data.; In this dissertation, I analyze the period of financial liberalization of emerging markets, including data up until June 1997. By focusing on possible changes in the return patterns directly associated with the emergence, I suggest that more modest expectations should have been formed. In the first chapter, I present an introduction to the problem and a literature review.; In the second chapter, I focus on ten markets that are found to have abnormally high returns when analyzed using a simple Capital Asset Pricing Model. I find that most of the abnormally high returns came either before the market opened to foreigners, or during the liberalization period when changes in government policy opened the market to foreign investors.; In the third chapter, I use a regime-switching model in which the probability of a change in regime varies over the period. This approach provides a better explanation of why the distribution of returns varies over time. I also present evidence that the abnormally high returns are associated with the period around the time when the markets were opened to outside investors.; In the fourth chapter, I use a regime-switching autoregressive conditional heteroskedasticity (ARCH) framework to model the variance of returns. This approach reduces the effect of extremely large shocks, which are frequently seen in emerging markets. I present evidence that a switching model that conditions the probability of switching on liberalization events provides better forecasts than commonly used models which do not allow for such changes. |
