Essays on the financial market efficiency of emerging markets

The recent emergence of equity markets in developing countries followed by their capital market liberalizations represents a new challenge for both investors and researchers. While features such as high average returns and low correlations with developed markets are attractive for large yield and diversification potentials, large and persistent fluctuations cast some doubt on the capability of these markets to value investment opportunities efficiently and accurately. Especially with a number of recent crises, the efficiency of these markets is under intense scrutiny.; The objective of my thesis is to evaluate the efficiency of emerging markets as conveyed through high average returns and volatility. The thesis exploits cross-country data—data on both emerging and developed economies—to assess the relative efficiency of emerging markets.; In the first chapter, the relative efficiency of emerging markets is explored by examining the sources of their high volatility. According to the efficient markets hypothesis, the competitive market equilibrium price should reflect its intrinsic or fundamental value: the hypothesis attributes fluctuations in asset prices entirely to the arrival of news about their fundamentals.; Contrary to the predictions of the hypothesis, movements in fundamentals fail to explain a substantial portion of emerging market volatility. Furthermore, a cross-country regression analysis shows that excess volatility is significantly greater in emerging markets compared to developed markets. Among the possible explanations, namely the shortcomings of small sample estimation; non-fundamental factors such as irrationality of agents and incomplete information and learning effects seem more promising to explain excess volatility.; The second chapter relates the high mean returns of emerging markets to their efficiency. This essay examines whether high risk-expected return characteristics of emerging markets are consistent with the consumption-based capital asset pricing model (CCAPM).; The results give little support for the model. Cross-country differences in consumption risk fail to explain variations in equity premiums. Moreover, the excess equity premium is significantly greater in emerging than in developed markets. Controlling for the usual suspects, such as liquidity constraint and financial system development, does little to reduce the excess equity premium in emerging markets. In contrast, alternative risk factors, such as country-specific risks and noise trader risks, have some explanatory power.