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Movement In African And European Stock Markets Finance Essay

This research will focus on co-movement in African and European stock markets. Co-movement is the tendency of two variables to move together in parallel. Knowing to what extend stock markets or financial assets move together is valuable information for investors. It makes it easier to predict future returns, it helps in putting together a well diversified portfolio and it helps to minimize risk. This is why co-movement is a popular topic in financial research. With the rise of emerging markets in the late 1980s, co-movement studies were more focused on developing markets in Asia, Central Europe and Latin America. The main goal of these studies was to find out if and how the emerging markets are influenced by developed financial markets. In this research I will investigate the relationship between African and European stock markets. In particular I would like to find out if African and European stock markets move together in parallel. I will use the returns of ten African stock markets over fifteen years and compare it with data from European stock markets. I will use Granger causality to investigate whether there is co-movement between African and European stock markets. The ultimate goal of this paper is to provide new knowledge about African stock markets which can help investors make better investment decision. In particular I would like to find out whether adding African stocks to an international portfolio will improve the portfolio by increasing the diversification effect.

Africa is not the first place that comes to mind when deciding where to invest your money. The world’s poorest continent has a bad reputation and is typically portrayed in a negative way. Raging wars, hunger and diseases, extreme poverty and government corruption scare investors away and make them think twice before even considering investing their money in African stocks. Fortunately, there is another side of Africa that more and more people come to know.

Business is booming in Africa. Although Africa’s growth is mainly driven by petroleum products, other sectors are also showing impressive growth rates. One of these sectors is telecommunications. Over the period 1999-2004, the use of cellular phones in Africa increased by 58% per year (UNCTAD). Africa is expected to become the number one oil supplier to the United States, and already is China’s biggest supplier in oil (UNCTAD). A growing number of investors recognize the investment opportunities the continent has to offer. Africa receives an increasing amount of positive attention in financial media and more and more institutional investors are including African stocks and indices in their funds.

The number of stock markets in Africa has more than quadrupled over the past twenty years, with more than twenty stock markets in 2011. With an average annual return of more than 38% over the last fifteen years these stock markets have performed very well. Critics might claim that these numbers are based on the African currencies, which could be considered unstable and risky. This argument is only partially true. Even if we convert Africa’s growth numbers in dollar terms the performance remains impressive with an annual average return of more than 21% (Senbet and Otchere, 2008). In contrast, the NYSE averaged about 10% in the last fifteen years.

With investors becoming more and more interested in Africa, there is a growing need for knowledge and information about African stock markets. Are African stock markets a safe place to invest? Do African stock markets behave like stock markets of other emerging markets? How do African stock markets react to crises? What about stability and liquidity? These are only a few questions that investors would like to see answered before they can make solid investment decisions. Unfortunately it seems the academic world is not eager to study African financial markets and to start answering these questions. Most of the research about emerging markets focuses on Asia and South America. The few articles that do focus on Africa are, for the large part, written by African researchers.

In my opinion, African financial markets need, and deserve, more attention from the academic world. The benefits are threefold. Firstly, Africa provides a new, and relatively unexplored, research field. Existing theories about emerging markets can be put to the test and new theories can be discovered. Since Africa is becoming more important to the global economy, understanding African stock markets could contribute to understanding the global economy, and the global financial system, as a whole. Secondly, the results from academic research can help investors make better decisions. Africa is still unattractive to many investors because there is so little known about African stock markets. The academic world can provide knowledge and understanding and can thus make Africa more attractive to investors. Thirdly, and in my opinion most importantly, foreign investments can stimulate financial growth on the continent. African businesses thrive from foreign investments, grow stronger and therewith create jobs and hopefully contribute to financial and economic stability where it is needed most. In section 2 of this research I will elaborate on the importance of well functioning financial markets for economic growth.

With this research I intend to discover a little bit about the way African stock markets behave and attempt to contribute to the knowledge about African stock markets. I am particularly interested in finding out whether African stock markets move together with European stock markets. In my research I will try to answer two questions.

Question 1: Is there co-movement between African and European stock market returns?

This question forms the basis of my research. By answering this question I can provide valuable information to investors who consider investing in African stock markets. It will help predict how the risk of an international portfolio will change when African stocks are added. In section 2 of this proposal I will elaborate on the importance of studying co-movement in stock returns, and why this is particularly interesting for African stock markets.

Question 2: Is there excess co-movement between an African country’s stock market and the stock market of its former colonist?

The second question is similar to the first question, but focuses on co-movement between two specific countries. Most countries in Africa have been colonized by European countries and were subject to European laws and government. Although all countries in Africa have regained sovereignty, they still have strong ties with their former colonists. For example, France is the leading supplier and foreign investor of Benin. Over 250 French businesses are operating in Senegal. British oil companies BP and Shell are operating intensively in former British colony Nigeria. It would be interesting to see if the special relations that African countries have with their former colonists are also reflected in the stock markets.

In answering the two research questions, I will focus in particular on the practical implications of the outcome of the research. I will look at the outcome from an investor’s point of view and will explain how my research can help investors make better decisions. In particular I would like to find out whether creating a portfolio of African and European stocks is a good investment decision.

The continent of Africa is usually divided into northern Africa and sub Saharan Africa. Northern Africa is considered to be part of the Arab world, and shows few cultural similarities with the rest of Africa. From an investor’s point of view however, there is no ground for separating the two regions. Since I will study each stock market individually, there is no reason to exclude Arab stock markets from the research. It can only provide more information about co-movement.

This research proposal continues as followed: Section 2 will provide an extensive literature review and will explain why the two research questions are a valuable contribution to the existing academic literature. Besides reviewing relevant studies, this section will also explain the current state of the African stock markets, why Africa needs stock markets, and the importance of studying co-movement. Section 3 will state the hypotheses for the research questions and provides expectations for the outcome. Section 4 will explain which data will be used and which methodology will be implemented to conduct the research.

2. Literature Review

The literature review will be divided into three parts. The first part will discuss relevant literature about co-movement and explains how it relates to international portfolio diversification. I will review a number of co-movement studies in emerging markets and identify the research techniques used for testing co-movement. Part two of the literature review will discuss relevant literature about African economies and African stock markets. I will discuss the current state of the African stock markets, issues and weaknesses they have and ways they can develop in the future. I will also asses the political and economic relationship between Africa and Europe which can help make predictions about the outcome of my research. The final part will be a brief conclusion of the literature review and will explain the relevance of my research.

2.1 Co-movement

2.1.1 Co-movement and International Portfolio Diversification

We define co-movement as the tendency of two variables to move together in parallel. In this paper we are interested in the tendency of African stock market returns to move in parallel with European stock market returns. Co-movement in stock market returns is an important topic in empirical financial research, as it has strong practical implications in portfolio management, risk management and asset allocation. In 1952 Harry Markowitz laid the foundation for modern portfolio theory by showing that portfolio risk can be reduced by adding securities to a portfolio. He showed that although security returns for a particular country are highly positively correlated, they are not perfectly correlated, which allows for a reduction of risk trough diversification (Markowitz, 1952). Later in 1968, Herbert Grubel was the first to apply the theoretical framework of Markowitz to international diversification. He found that international diversification can significantly reduce portfolio risk and refers to it as “a new kind of world welfare gains from international economic relations, different from both the traditional "gains from trade" and increased productivity flowing from the migration of the factors of production” (Grubel, 1968). Two additional papers about international diversification worth mentioning are those of Levy and Sarnat (1970) and Solnik (1974). In their paper, Levy and Sarnat constructed a correlation matrix of average annual returns of 28 countries in order to test the benefits of international diversification. Their research shows that there is much less correlation between securities from different countries and therefore the diversification effect of adding securities to a portfolio can be increased when foreign securities are included. Solnik (1974) draws a similar conclusion in his paper but adds that the risk of investing in foreign securities should not be assumed to be due only to price variability. The benefits of international diversification are reduced by many political, institutional and psychological factors. He points out that investors may for instance be concerned with possible restrictions on foreign holdings and impositions of exchange controls. This might indeed be a serious concern for investors who are considering African securities. Solnik also emphasizes the existence of exchange rate risk, which is also a significant risk when looking at African stock markets. Although the testing for co-movement in my research does not take into consideration political, institutional and exchange rate risk, it will be reflected on in the conclusion of my research.

Hui et al. (1993) have neatly summarized the above in their paper about portfolio diversification. They explain that the more stock prices move in parallel, the less the diversification effect when they are both included in the same portfolio. In portfolios limited to a single country’s securities, the returns of individual securities tend to move in a synchronized matter, which makes diversification more difficult. By investing across countries the returns of individual securities in a portfolio are more likely to move independently from each other. International diversification can thus be beneficial because investment portfolios will be less vulnerable to the intracountry systematic risk (Hui et al., 1993).

Testing for co-movement between African and European stock markets allows us to make assumptions about the potential benefits of international diversification with African securities. A high degree of co-movement would imply that the diversification effect of a portfolio consisting of African and European stocks would be limited, at least on the basis of geographical diversification. Of course such a portfolio could be well diversified if securities are picked across industries and across different security types, but the effect of the geographical diversification would be limited. A low degree of co-movement would imply that spreading one’s investment across African and European securities has a substantial diversification effect because the systematic risk related to a specific geographical region would be significantly reduced. This information could be very helpful to investors who are considering adding African stocks to their portfolio.

The outcomes of co-movement studies not only help make better investment decisions, they also help understand the functioning of the global financial system as a whole. This is especially important when assessing the contagious effects of financial crises. This is of course of special importance for developing financial markets like those in Africa, which might be incapable of absorbing the shock of a financial crisis.

2.1.2 Co-movement in Emerging markets

There is an abundance of studies which aim to determine how and to what extend stock markets affect each other. For instance Hilliard (1979) examined correlation in closing price changes among 10 financial markets. Jaffe and Westerfield (1985) studied daily closing price changes British, Canadian, Australian, Japanese and U.S. financial markets. Eun and Shim (1989)

Since the late 1980s emerging markets have sparked the interest of the investment community. Emerging markets returns differ from developed markets in at least four ways: the average returns are higher, correlation with developed market returns is low, returns are more predictable and volatility is high. Obviously the first three characteristics have a positive effect for investors, the fourth is negative. Higher volatility increases capital costs and makes it more attractive for investors to wait or invest elsewhere (Bekaert and Harvey, 1997). In 1994, Harvy studied the effect of adding emerging market securities to a portfolio. By testing 6 different investment strategies with data from 20 developed countries and 21 emerging countries Harvey found out that the low correlation with developed markets and the higher predictability of returns made emerging market securities a valuable addition to a portfolio, which resulted in higher expected returns and lower portfolio volatility (Harvey, 1994).

With the growth of Asian economies, researchers became interested in the co-movement of Asian stock markets with the developed markets in the US, Europe and Japan. For example, Soenen and Johnson (2002) studied daily returns from 1988 to 1998 of twelve Asian equity markets to find out to what degree these markets are affected by the Japanese stock market. They found that equity markets in Australia, China, Hong Kong, Malaysia, New Zealand, and Singapore are highly correlated with the Japanese market, and that this correlations increases over time. According to them, this increase is caused by an increase in imports and exports and an increase in co movement.

Morck et al. (1999) have also studied co movement in emerging markets. They found that equity markets in countries with a low per capita gross domestic product (GDP) show more co-movement than countries with high per capita GDP. According to them this is not because of structural characteristics of the economies, such as country size, economy diversification and market size, or firm level fundamentals. Although these characteristics explain some of the correlation, the majority is caused by less respect for private property by the government. This causes more market wide stock price variation, which in turn causes more synchronous stock price movements. These findings could help explain possible correlation between African and European stock prices.

Although there have been many co-movement studies aimed at emerging markets, there are, to my knowledge, no attempts to measure co-movement between African and European markets. Such a study would be valuable

2.1.3 Testing for Co-movement

Co movement has traditionally been measured by determining the correlation coefficient between two markets, often using an ARCH or GARCH model. Both King and Wadhwani (1990) and Bertero and Mayer (1990) used this method in their often cited papers about the worldwide stock markets crash in October 1987. Although this method has been criticized for producing unreliable results, for instance by Forbes and Rigobon (2002), it is still an often used approach when testing for co-movement. Another method for testing correlation is the Granger causality test, or G-causality test (Granger, 1969), named after its inventor, Nobel prize winner Clive Granger. In section 4 of this paper I will elaborate on the G-causality test, which will be the research method for this study.

2.2 African stock markets

There are 26 stock exchanges in Africa, representing the capital markets of 36 countries. Africa has two regional stock exchanges; the Bourse Régionale des Valeurs Mobilières (BRVM) and the Bourse Régionale des Valeurs Mobilières d’Afrique Centrale (BVMAC). Africa’s regional stock exchanges will be discussed in more detail later. Africa’s oldest and largest stock markets are the Egyptian Exchange (EGX) in Egypt and the Johannesburg Stock Exchange (JSE) in South Africa, which were established in 1883 and 1887 respectively. In terms of market value they are comparable to the stock markets in the Nordic countries, Italy or South Korea. Out of the 28 stock exchanges, 21 are members of the African Securities Exchanges Association (ASEA), an organization that facilitates the development of stock exchanges through integration and information sharing.

The development of African stock markets has witnessed a significant growth over the last two decades. Besides the rapid growth in the number of stock exchanges in Africa, there have also been extensive reforms in the financial sector undertaken by African governments. These reforms include removal of credit ceilings, restructuring and privatization of state-owned banks, improvements in supervisory and regulatory schemes and interest rate liberalizations (Senbet and Otchere, 2008).

The African stock markets have shown tremendous growth over in both size and return… Tell about the success stories of African stock markets.

Then explain the drawbacks/problems (starting with Senbet and Otchere).

2.2.1 African stock markets: weaknesses and constraints

In their paper, Senbet and Otchere (2008) provide an extensive overview on the current state of African stock markets. One of the biggest issues is the illiquidity of markets. In most markets the number of listed shares is small, trading activity is low and markets are dominated by only a few listed companies. Besides having liquidity issues, African stock markets also face operating problems. Operational and settlement procedures are slow and brokerage services are poor. While the rest of the world has automatic systems, many of the African exchanges still have manual systems, which can result in transactions taking weeks before they are executed. Another major concern for investors is the economic and political instability of African countries. The biggest problem here however is not so much the actual risk, but the perceived risk in the eye of the investor. Senbet and Otchere (2008):

The average quality of the Africa “pool” may mask the high quality of the reforming countries due to the monolithic view of Africa as a single, troubled "country" (i.e., pooling equilibrium). This information gap can be minimized through the provision of timely and reliable data required for making estimates of investment risks in Africa. Consequently, there is a need for more extensive, detailed and reliable economic and capital market data that captures the diversity of Africa.

2.2.2 African stock markets: future development

An interesting feature of the development in financial markets in Africa is the emergence of a regional stock market serving eight West African countries. The Bourse Régionale des Valeurs Mobilière (BRVM), seated in Ivory Coast, integrates eight Francophone countries of the West African Economic and Monetary Fund (WAEMU [1] ). The bourse was established in 1998 and has branches in each member country. The member states own 13% of the market, the other part is owned by the private sector. This regional approach has many benefits, including economies of scale, better regulations and higher liquidity. Because of the success of the BRVM, many analysts suggest further regionalization of stock markets in Africa to address liquidity problems, reduce costs and improve regulations. A well integrated regional stock exchange can be a powerful source and driver of capital flows to Africa (Adjasi and Yartey, 2007).

Besides the forming of regional stock exchanges, Adjasi and Yartey (2007) discuss six other ways in which African stock markets can develop. One way to improve is to adopt automatic transaction systems, which would reduce trading costs and increase liquidity and trading activity. Secondly, demutualizing stock markets, a process in which the legal status, governance and structure of an exchange change from a non-profit and protected interest to a profit one, can have positive effects on their development. These effects include competition among exchanges, need for good corporate governance in exchanges, need for increased capital and the urge to open up ownership of exchanges to public investors (Pirrong, 2000). Thirdly, strengthening of supervision and regulation helps protect investors by reducing the possibility of illegal opportunistic behavior by insiders. Fourthly, the participation of institutional investors should be pursued. Pension funds, insurance companies and other institutional investors promote financial innovation and efficient market practices. They typically favor greater market integrity and transparency, seek lower transaction cost, and demand more efficient trading and settling. The involvement of institutional investors can thus encourage banks and intermediaries to be more efficient and transparent. Fifthly, the attraction of capital flows and foreign participation are important for stock market development, mainly because it will increase liquidity and trading activity. Sustained economic growth, quality public institutions and infrastructure, trade liberalization, and efficient capital markets are important for attracting capital flows (Asiedu, 2006). Finally, Adjasi and Yartey (2007) stress the need for increasing the public knowledge about the functioning of stock markets. Educating businesses about the benefits of listing, and thus taking away the fear of losing control, can increase the number of listings in the African stock markets. Education can also encourage people to invest money in stock markets instead of other investments or bank savings.

2.2.3 Stock Markets and Economic Growth: Examples from Africa

Stock markets are beneficial to a nation’s economic growth for a number of reasons. In principle, a stock market is expected to foster economic growth because it provides a boost to domestic savings and increases the quality and quantity of investments (Singh, 1997). The stock market provides individuals with additional financial instruments that might better meet their risk/return preferences and liquidity needs. This improvement in savings mobilization could increase the economy’s savings rate (Levine and Zervos, 1998). Besides a potential increase in savings, stock markets also provide growing companies with an opportunity to raise capital at lower costs. Furthermore, with the presence of a developed stock market companies are less dependent on financing through bank loans, which could possibly reduce the risk of a credit crunch. Hence, stock markets are able to accelerate economic growth by encouraging savings and providing alternative ways of financing for companies.

In theory stock markets ensure that investments are used most efficiently. The threat of a takeover provides management with an extra incentive to maximize the value of the firm. If management fails to do so, other economic agents may take control of the firm and replace management. Stock markets are therefore expected to provide financial discipline and therewith a guarantee of efficient use of assets. Similarly the voting power of shareholders will also ensure managerial resources are allocated most efficiently (Kumar, 1984).

Efficient stock markets are also expected to reduce the cost of information. Stock markets are considered efficient when prices of listed shares incorporate all available information….

They may do so through

the generation and dissemination of firm specific information that efficient stock prices

reveal. Stock markets are efficient if prices incorporate all available information. Reducing

the costs of acquiring information is expected to facilitate and improve the acquisition of

information about investment opportunities and thereby improves resource allocation. Stock

prices determined in exchanges and other publicly available information may help investor

make better investment decisions and thereby ensure better allocation of funds among

corporations and as a result a higher rate of economic growth.

Stock market liquidity is expected to reduce the downside risk and costs of investing in

projects that do not pay off for a long time. With a liquid market, the initial investors do not

lose access to their savings for the duration of the investment project because they can easily,

quickly, and cheaply, sell their stake in the company (Bencivenga and Smith, 1991). Thus,

more liquid stock markets could ease investment in long term, potentially more profitable

projects, thereby improving the allocation of capital and enhancing prospects for long-term

growth. It is important to point out, however, that, theory is ambiguous about the exact

impacts of greater stock market liquidity on economic growth. By reducing the need for

precautionary savings, increased stock market liquidity may have an adverse effect on the

rate of economic growth.

Critics of the stock market argue that, stock market prices do not accurately reflect the

underlying fundamentals when speculative bubbles emerge in the market (Binswanger,

1999). In such situations, prices on the stock market are not simply determined by

discounting the expected future cash flows, which according to the efficient market

hypothesis should reflect all currently available information about fundamentals. Under this

condition, the stock market develops its own speculative growth dynamics, which may be

guided by irrational behavior. This irrationality is expected to adversely affect the real sector

of the economy as it is in danger of becoming the by-product of a casino.

Critics further argue that stock market liquidity may negatively influence corporate

governance because very liquid stock market may encourage investor myopia. Since

investors can easily sell their shares, more liquid stock markets may weaken investors’

commitment and incentive to exert corporate control. In other words, instant stock market

liquidity may discourage investors from having long-term commitment with firms whose

shares they own and therefore create potential corporate governance problem with serious

ramifications for economic growth (Bhide, 1994).

Critics also point out that the actual operation of the pricing and takeover mechanism in well

functioning stock markets lead to short term and lower rates of long term investment. It also

generates perverse incentives, rewarding managers for their success in financial engineering

rather than creating new wealth through organic growth (Singh, 1997). This is because prices

react very quickly to a variety of information influencing expectations on financial markets.

Therefore, prices on the stock market tend to be highly volatile and enable profits within

short periods. Moreover, because the stock market undervalues long-term investment,

managers are not encouraged to undertake long-term investments since their activities are


judged by the performance of a company’s financial assets, which may harm long run

prospects of companies (Binswanger, 1999). In addition, empirical evidence shows that the

takeover mechanism does not perform a disciplinary function and that competitive selection

in the market for corporate control takes place much more on the basis of size rather than

performance (Singh, 1971). Therefore, a large inefficient firm has a higher chance of survival

than a small relatively efficient firm.

These problems are further magnified in developing countries especially sub-Saharan African

economies with their weaker regulatory institutions and greater macroeconomic volatility.

The higher degree of price volatility on stock markets in developing countries reduces the

efficiency of the price signals in allocating investment resources. These serious limitations of

the stock market have led many analysts to question the importance of the system in

promoting economic growth in African countries.

2.3 Relevance

Although much has been written about co-movement and co-movement in emerging markets, there is no study that compares the stock markets of Africa with the stock markets of Europe. Co-movement in African markets has been explored by Kabundi and Loots (2005). They investigate the co-movement between South Africa and the South African Development Community (SADC) member states. However, their paper focuses on macro-economic factors and does not deal with stock market returns.

This study can be a valuable contribution by being the first to study co-movement between African and European stock markets. Another aspect of this study that has not yet been explored before is the possible special relationship between stock markets from countries and their former colonies.

I have already briefly explained that studying African stock markets can also be valuable for the economic development. McKinnon (1973) wrote a seminal paper on money and capital in economic development, in which he stresses the importance of well functional financial systems for developing economies. He also states that foreign investments can play a significant role in economic development. Since his work, many researchers have underscored the importance of foreign investment and good functioning financial systems.

3. Hypotheses

Before I conduct the actual test I will look at the raw data and previous literature to draw preliminary conclusions about the outcome. Figure 1 plots the MSCI index for Europe and selected African countries over a period of ten years. Figure 2 does the same with the S&P Broad Market Index. Both figures are available in Appendix A. At first glance, we see that the African stock markets, in general, move in a similar fashion as the European stock markets. We can see that from the year 2000 until mid 2002, the majority if the graphs show a decline. Then from mid 2002 until mid 2007 we witness steady increases in price levels. Then, as a result of the financial crisis that started end 2007, all stock markets show a sharp decline, followed by a steep recovery in late 2008. These figures suggest I will find a positive relationship between Africa and Europe.

The study by Morck et al. (1999), which was mentioned earlier in this paper, showed that stock prices in countries with a low per capita gross domestic product (GDP) tend to move up and down together, whereas stock prices in high per capita GDP countries move unsynchronized. Although their findings do not say anything about co-movement between low and high per capita GDP countries, which is the subject of this research, they do increase the probability of finding a positive relation between African and European stock markets. If only a few stocks in a certain African stock market are influenced by movements in Europe, then, according to Morck et al. (1999), these stocks will influence the rest of the market.

In their study about co-movement in Asia, Soenen and Johnson (2002) found that several countries show an increasing correlation with Japan, which is caused by an increase in foreign direct investments, and an increase in imports and exports. According to a 2008 report on the economic development in Africa from UNCTAD, Europe is Africa’s most important trading partner, and receives more than 40% of Africa’s export products. However, Europe’s importance is declining (from 66% of all African exports in 1960), and Asia and North America are receiving an increasing amount of African products. Because Europe is still Africa’s number one export destination, I expect to find, based on the findings of Soenen and Johnson (2002) a positive relation between African and European stock price movements.

In conclusion of the above I state my hypothesis as followed:

I expect to find co-movement between African and European stock markets. I expect to see the returns of African stock markets moving in parallel with the returns of the European stock markets. I expect stronger co-movement between African stock markets and the stock market of their former colonist. I also anticipate stronger co-movement when the African stock market is less developed.

4. Data Collection and Research Methodology

The African stock markets are probably the worst documented of all stock markets worldwide. This makes the data collection for this research a serious challenge. There are three issues that need to be overcome in order to create a usable dataset for the analyses. Firstly, there is no single index for all countries that can be used to perform the analysis. Well known indices like the, FTSE All Share, MSCI or the S&P Broad Market Index are not available for all countries or are only available for a period of a few years. Secondly, many indices are only recorded on a monthly or weekly basis. Most co-movement studies use daily data in their analysis. The final problem is the poor availability of indices in one common currency. For most countries, the indices are only available in local currency. The indices denominated in US Dollars are often the “newer” indices and are only recorded since a few years.

In an ideal world, I would use the same index for all countries, data that is updated daily and in a single currency, preferably Euros or US Dollars. All analyses would be performed over a period of at least ten years. Since the data available is far from ideal, compromises have to be made. Some indices are recorded in dollar terms, but only go back a few years. Others are available for a period of over ten years, but only show monthly data. In order to choose the most suitable data, I will select the indices according to the following criteria. Firstly, the same index must also be available for Europe, the United Kingdom and/or France (whichever is necessary to answer the second research question). If this criterion is met, I will pick the indices that show data over a period of at least ten years. I will then look at the indices that have the shortest data interval (monthly vs. weekly). The currency in which the index is recorded is the least important feature. If indices are recorded in local currency I will calculate the US Dollar numbers manually by using the historical exchange rates. In accordance with the above mentioned criteria, table 1 shows the data sets that will be used for the analysis.


Index name

Base Date



Eur. Comparison

Colony Comparison


S&P Botswana BMI




S&P Europe BMI



MSCI Egypt




MSCI Europe



S&P Ghana BMI




S&P Europe BMI


Ivory Coast

S&P Ivory Coast BMI




S&P Europe BMI

S&P France BMI


S&P Kenya BMI




S&P Europe BMI



S&P Mauritius BMI




S&P Europe BMI



S&P Namibia BMI




S&P Europe BMI



MSCI Morocco




MSCI Europe

MSCI France


S&P Nigeria BMI




S&P Europe BMI


South. Africa

MSCI South Africa




MSCI Europe


Tabke 1. Indices that will be used for the analyses.

The Granger causality test, which has already been briefly discussed, tests co-movement by determining whether a certain time series is useful in forecasting another time series. In this study we want to study co-movement by testing whether the movements of European stock markets are useful in forecasting the movement in African stock markets. The test will be conducted by first performing a regression of Pa on past values of Pa, where Pa is the value of the price index of African country a. The test will be done over a ten year sample period (nine years in the case of Namibia), I will then conduct the same test, but also include past values of PE, where PE is the value of the price index of Europe. We then test, under a 95% significance level, whether the past values of PE significantly improve the prediction of Pa. If this is true, we can infer correlation by claiming that movements in the European stock markets “Granger cause” movements in African stock markets.

In the interpretation of the results I will compare the co-movement of the ten African countries with each other and over time. If the analyses show positive correlations, I will use the findings of Morck et al. (1999) and Soenen and Johnson (2002), which were discussed in the literature review, in a first attempt to explain this co-movement. The main goal of this research is to use the outcome in formulating practical implication for investors.

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