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Do foreign investors stimulate or inhibit stock market development in Latin America?

I. INTRODUCTION

Growing participation by foreign institutional investors has been a key force in the development of Latin American stock markets since 1990 while the accelerating trends of institutionalization and globalization of money management will increase the importance of these investors for the future development of stock markets in emerging economies.

As the value of global institutional assets has grown, a larger share has been invested internationally and emerging markets now comprise a growing share of this international allocation. The size of assets managed by institutional investors in the largest industrialized countries reached $17 trillion in 1994, up from $2.4 trillion in 19801 with U.S. pension and mutual funds accounting for the largest share, valued at $3.8 and $2.1 trillion respectively. The allocation of U.S. pension fund assets to foreign securities increased from 0.7% in 1980 to 5.7% in 1993 and 9.5% by 1995, slightly below the 10.1% allocation of U.S. mutual funds in 1993 while the value of international investments by pension funds worldwide surged from $302 billion in 1989 to $790 billion by 1994.(2)

The increasing share of emerging markets in this expanding pool of mutual and pension fund assets is evidenced by the fact that only 26 dedicated emerging market funds existed worldwide in 1986 with $1.8 billion in assets compared to 1,254 funds and $109 billion in assets by 1995.(3) The percentage of non-dedicated mutual funds invested in emerging markets has also grown, from 2% to 12% between 1989 and 1995. U.S. pension funds have dedicated a smaller portion of their larger asset base to emerging markets. Current estimates for U.S. pension fund holdings are between $50 and $70 billion dollars, similar to the amount for U.S. based mutual funds.(6)

This paper examines the interaction between the forces of globalization and institutionalization of money management and the development of emerging stock markets in Latin America. First, after motivating the importance of stock markets for economic growth, the theoretical impact of integration on stock market development is examined. Second, the stages of foreign participation in Latin American stock markets are investigated to determine the impact of this participation on stock market development.

II. STOCK MARKET DEVELOPMENT AND ECONOMIC GROWTH

Economists have often claimed that the evolution of financial markets is an important factor stimulating economic growth. Schumpeter (1911) argued that the services provided by financial intermediaries are essential for technological innovation, "The banker..authorizes people, in the name of society as it were, to...innovate." The work of Goldsmith (1969), McKinnon (1973) and Shaw (1973) and the resurgence of interest into the sources of economic growth during the 1990s have once again brought the importance of financial markets to the forefront of the policy debate in many emerging economies.

Many authors have documented a positive correlation between economic growth and indicators of financial market development. However, the direction of causality and the channels by which the two variables are associated have only been addressed recently. King and Levine (1993) find evidence of causation from financial development to growth by demonstrating that financial development is not only associated with current growth, but also influences future growth, investment and the efficiency of these investments. Levine and Zervos (1995a) show that stock market development, particularly stock market liquidity, is robustly correlated with future economic growth. They also demonstrate that even after adding indicators for the development of the banking system, stock market development remains significant. This implies that stock market and banking system development play complementary roles. Stock markets may be better at diversifying risk and providing liquidity to small investors while the banking system may be better at reducing informational asymmetries important in financing smaller companies.

Attempting to explain the above empirical findings, Bencivenga, Smith and Starr (1992), Levine (1991), Saint-Paul (1992) and Greenwood and Jovanovic (1990) show how liquid secondary capital markets help to allocate funds to projects with the highest marginal product, stimulating economic growth. Stock markets increase the productivity of capital by improving liquidity, enhancing portfolio diversification opportunities and gathering information on the profitability of risky projects.

Long-term investments in physical capital may have higher returns than short-term liquid investments. However, investors face unpredictable liquidity shocks which force the premature liquidation of long-term investments. Stock markets increase the willingness of individuals to invest in less liquid, more productive technologies by allowing these individuals to retain liquidity by selling their shares on the stock market. The availability of liquid capital markets thereby lowers the cost of capital, increases investment in more productive long-term assets and leads to higher rates of economic growth.

An equity market encourages portfolio diversification of firm specific risks. This allows each firm to specialize in riskier projects, helping to increase productivity without an increase in systematic risk. Consequently, productivity growth may be higher in an economy with a diversifiable equity market. Stock markets also give incentives for individuals to acquire information about companies. More liquid markets will offer greater opportunities for investors to profit from this information. These incentives will result in more research and monitoring of firms, improving the resource allocation role of the market.

However, the benefits of stock market development require that these markets be active. Few emerging markets would have met this condition before 1990. Therefore, understanding how emerging economies can stimulate the development of stock markets is at least as important as examining their impact on economic growth once they are developed. We now turn to the potential role of foreign investors in stimulating stock market development.

III. FOREIGN PARTICIPATION AND STOCK MARKET DEVELOPMENT

Pagano (1989b, 1992) claims that participation externalities are important in explaining why the relative size of stock markets at comparable levels of economic development differ significantly. A market with very few companies will not attract many investors, inhibiting the development of a liquid secondary market for these companies. Conversely, a market with few investors will not attract many companies to issue securities, limiting the diversification benefits available for investors. Low liquidity, limited diversification and high volatility may be self-perpetuating.

Participation externalities can lead to multiple equilibria, where high-level Pareto equilibria dominate low-level equilibria. Greater participation makes a market more liquid by reducing the sensitivity of market prices to the sale of equity (Pagano, 1989a) and enhances the benefits of diversification for investors and companies deciding to enter the market (Pagano, 1992). An exogenous shift in the number of market participants can increase the expected liquidity and diversification benefits and lead to the development of the stock market. This paper argues that the opening of these markets to foreign investors has helped to move these markets out of the low equilibrium trap into a higher equilibrium with greater liquidity and diversification benefits.

Hargis (1997a) and Hargis and Ramanlal (1997) demonstrate the link between capital market integration and domestic stock market development. Integration should stimulate stock market development by increasing the size of the market and enhancing the liquidity of companies traded, helping the markets to provide the diversification, liquidity and informational roles which stimulate economic growth.

The size of the market will increase from both higher stock prices and the entry of more companies into the market. International asset pricing models (Alexander, Eun and Janakirmanan, 1986; Errunza and Losq, 1985) demonstrate that stock prices should increase and the required rate of return of a stock should decline when moving from segmented to integrated markets. Since the correlations among companies in the same country are higher than those between companies in different countries, the systematic risk of the company declines. This reduced risk under integration lowers the return required by investors for holding the company. More companies will issue stocks in the market after integration because of the higher price received for issuing equity.

Investment liberalizations which lead to integration such as closed-end country funds, American Depositary Receipts (ADRs) and elimination of foreign investment restrictions in the domestic market can also improve domestic market liquidity. The intuition is that in a market with a low number of market participants, liquidity shocks are not able to be absorbed without large adjustments in prices. Integration increases domestic market liquidity by accessing a larger number of investors to trade and purchase the company's stock. The benefits of improved liquidity will depend on the degree of transparency with the foreign market, prior foreign ownership restrictions and the relative size of the domestic market (Hargis and Ramanlal, 1997).

IV. EVOLUTION OF FOREIGN PARTICIPATION IN LATIN AMERICAN STOCK MARKETS

Foreign participation in Latin American stock markets has proceeded through a number of stages. During the first stage prior to 1989, domestic markets were largely segmented from world markets with little foreign participation. In the second stage between 1989 and 1991 most Latin American markets liberalized restrictions on foreign ownership, increasing foreign participation in the domestic markets. Since the beginning of the third stage, with the listing of Telefonos de Mexico in May 1991, numerous Latin American equities have listed in the United States creating competition between stock exchanges in Latin America and the U.S. for trading in Latin equities.

Prior to 1989, closed-end country funds were the primary foreign investment vehicle in Latin America. The Mexico Fund, listed on the New York Stock Exchange in 1981, was the first closed-end country fund in emerging markets. The first U.S. listed closed-end country funds investing in Brazil, Chile and Argentina were launched in 1988, 1989 and 1991 respectively (see Table 1).

Prior to changes in the foreign investment regulations in Mexico during May 1989, foreign investment was constrained to a few shares accessible to foreign [TABULAR DATA FOR TABLE 1 OMITTED] investors(6) while foreign participation in Argentina, Brazil and Chile was not significant in the domestic market. Although many Mexican companies had issued shares open to foreigners, most of the stocks were owned by joint venture partners who did not want to sell their stake. Two Mexican companies were also listed in the U.S. in the form of ADRs.

Between 1989 and 1991, Mexico, Brazil and Argentina liberalized restrictions on foreign ownership in the domestic market. In May 1989, the foreign investment law in Mexico was reinterpreted which resulted in the setting up of the Nafinsa trust in November 1989. This mechanism allows previously prohibited foreigners to invest in voting shares of Mexican companies by holding a non-voting certificate representing these shares. In May 1991, the Brazilian government modified its foreign investment code by eliminating the required 90 day holding period and portfolio diversification requirements. In addition, domestic companies were now allowed to issue equity abroad. Argentina liberalized restrictions on foreign investment in October 1991, virtually eliminating all limitations on foreign investment. The Chile Fund was listed on the New York Stock Exchange in September 1989. However, repatriation of capital is only allowed after one year, limiting the degree of foreign participation in the local market.

Since the May 1991 international offering of Telefonos de Mexico, most major equities listed in Latin America have issued ADRs in the U.S. The importance of ADRs will be examined in terms of their ability to replicate the returns on the domestic market, their share of total trading volume and significance as a source of portfolio equity flows.
Table 2. Foreign Investment Vehicles in Latin America

                                                 Closed-End
Country              Listed ADRs    All ADRs    Country Funds

Argentina                  9            20            1
Brazil                     2            49            3
Chile                     18            21            1
Colombia                   3            13            0
Mexico                    31            88            3
Peru                       1             8            0
Venezuela                  1            13            0

All Markets              354         1,546           99
Developed Markets        256           959           24
Emerging Markets          98           587           65

Latin America             65           226           15
Asia                      13           202           30
Europe                     3            38            6
Africa                    17           121            4

Note: Regional totals for country funds include regional funds,
emerging markets total includes global emerging markets funds. ADR
totals are as of March 1996 while country fund totals are as of
June 1995.

Source: Bank of New York and Lipper Analytical Services.


By March 1995, equities which accounted for over 87%, 54%, 62% and 71% of the Mexican, Argentine, Chilean and Brazilian local market indices were trading in the form of ADRs. Mexico had the largest number of listed ADRs with 31 while Chile, Argentina and Brazil followed with 18, 9 and 2 respectively as of March 1996. The Mexican market is also the source of the largest number of all forms of ADRs with 88 (see Table 2).(6) Latin American ADRs accounted for 66% of all listed ADRs from emerging markets and 18% of all companies listed on the New York Stock Exchange.

The significance of ADRs for foreign investors in Latin America relative to developed economies is demonstrated by the fact that during 1994 the value of Mexican companies traded on the New York Stock Exchange (NYSE) was greater than any other foreign country. In 1996, Brazil, Argentina, Chile and Mexico all ranked among the top nine countries in terms of value traded with Telebras and Telmex ranking as two of the top three foreign traded companies (see Table 3). Latin American ADRs also accounted for 90% of all trading by companies from emerging markets and 24% of trading by all foreign companies.

Trading of Latin equities in the U.S. has grown in importance relative to the domestic market as shown in Table 4. In 1994 and 1995 the total dollar value traded for Mexican, Argentine and Chilean ADRs in the U.S. were each greater than the value traded in their respective domestic markets, although only a portion of the domestic market is listed in the U.S. In 1995, U.S. trading accounted for 40% of value traded for Latin American equities, up from 12.1% in 1990.
Table 3. Trading Value for Non-U.S. Companies Listed on NYSE

                               Value Traded         Number of
Country                    (Millions of Dollars)    Companies

All Countries                     335,274              304

Developed Markets                 244,888              215

Emerging Markets                   90,386               89

Latin America                      81,103               66

1. U.K.                            60,264               42
2. Canada                          59,696               55
3. Netherlands                     46,912               12
4. Mexico                          29,391               25
5. Brazil                          25,801                2
6. Netherlands Antilles            15,300                2
7. Argentina                       12,445               10
8. Finland                         10,090                3
9. Chile                            9,584               18
10. France                          8,051               11

Note: Number of non-U.S. companies listed on the New York Stock
Exchange as of December 1996 and value traded during 1996.

Source: New York Stock Exchange.
Table 4 Total Domestic and U.S. Value Traded for Latin American
Stocks (Millions of U.S. Dollars)

                           Value Traded        Value Traded
Country         Year           ADRs           Domestic Market

Chile            90               92                 783
                 91              193               1,900
                 92              606               2,029
                 93            2,369               2,797
                 94            7,210               5,263
                 95           11,600              11,072

Argentina        90                0                 852
                 91                0               4,824
                 92                0              15,679
                 93            6,125              10,339
                 94           12,612              11,372
                 95           15,679               4,594

Mexico           90            2,577              12,212
                 91           13,498              31,723
                 92           26,261              44,582
                 93           37,307              62,454
                 94           83,496              82,964
                 95           54,400              34,377


ADRS have been the major source of portfolio equity inflows in Latin America since 1991 with the exception of Brazil. Table 5 shows the growth of international share offerings out of Latin America. The first company to issue equity in the U.S. after the debt crisis was Compania Telefonos de Chile in 1990. Since [TABULAR DATA FOR TABLE 5 OMITTED] then Latin companies have raised $23.7 billion in equity, with issuance peaking in 1993 at $6.0 billion. Latin America issues accounted for 33% of all issues from emerging markets from 1990 through 1996, while emerging market issues were 32% of total global issuance.

New issues represent only 30% of the $79.6 billion in portfolio equity flows to Latin America because since late 1993 a majority of flows have been into existing ADRs(7) or directly into domestic shares. From 1990 to 1992 flows from new issues were larger than flows into existing shares. However, from 1993 to 1996, new issues only accounted for 23% of total inflows. Overall flows to Latin America represent 45% of total flows to emerging markets, larger than their share of total issuance.

The share of ownership and trading by foreigners in the domestic market has increased as a result of these investment liberalizations. Foreign ownership is greatest in Mexico at 29% of market capitalization in 1996, up slightly from 1994 and significantly since 1989 when only 3.6% of the market was in the possession of foreign investors. Foreign ownership of the Brazilian market has also expanded from 1.4% in 1992 to 17.0% by 1995.

The importance of ADRs in attracting foreign investors has declined with the development of the domestic market. After the two Telmex issues in 1991 and 1992, ADRs accounted for 73.7% of foreign ownership in Mexico. This declined steadily through 1995 to 62% and more rapidly during 1996 to only 48.7% (see Table 6).

The liberalization of financial services in Latin America has also allowed foreign controlled investment banks to compete for domestic trading volume. Foreign controlled investment banks did not trade in Mexico until 1994. [TABULAR DATA FOR TABLE 6 OMITTED] Nevertheless, their share of the domestic market has increased from 0.4% in 1994 to 2.6% in 1995 and 15.1% for the first seven months of 1996.(8) In Brazil, ING Baring and Salomon Brothers control 16.5% of volume traded in the domestic market.(9)

The expansion of foreign investment banks in these countries also reflects the fact that domestic trading is increasingly done by foreign investors. In Brazil, the percentage of domestic value traded by foreigners increased from 6% in 1991 to 26.4% in 1995.(10) While official data are not available in other markets, it is estimated that over half of the actively traded equity in Argentina is in the hands of foreign investors while foreigners account for over 50% of domestic trading volume in Mexico.(11)

All of these measures demonstrate the growing importance of foreign investors for the pricing, liquidity and development of Latin American stock markets.

V. EVOLUTION OF STOCK MARKET DEVELOPMENT IN LATIN AMERICA

The theoretical claim of Section II was that internationalization, which shifts a domestic stock market from segmentation to integration, should result in the development of the domestic stock market. This section presents empirical evidence regarding the impact in Latin America of shifting from a segmented domestic equity market owned by domestic investors to a market with cross-listed equities and domestically traded equities owned by foreign investors.

Growing participation by foreign investors in markets which trade Latin American equities has been accompanied by their rapid development in terms of market capitalization and value traded since 1989. This is consistent with the finding of Levine and Zervos (1995b) that capital flow liberalization in emerging markets significantly increases their index for stock market development (composed of market capitalization, value traded and turnover). [TABULAR DATA FOR TABLE 7 OMITTED] Table 7 shows the expansion in size of Latin American stock markets since 1989. In 1990, total capitalization of these markets was only $66 billion. Their size reached $434 billion in 1996, recovering quite rapidly from the precipitous fall in prices after the Mexican crisis.

It is misleading, however, to attribute all of this growth to domestic stock markets. In Mexico, the capitalization reported includes shares which are in reality traded and located in the United States in the form of ADRs. The value of these shares peaked at $34 billion in 1993 and has remained at approximately 15% of market capitalization since 1993, up from only 1.8% in 1989.

Value traded has expanded even faster, increasing from $22 billion in 1990 to $245 billion during 1996. The Mexican crisis did not revert much of this growth, as value traded in 1995 remained greater than 1993. The increase in trading has been especially rapid for Latin equities traded in the United States, growing from $2.6 billion in 1990 to $103 billion in 1994. Although less dramatic, domestic value traded expanded from $19 billion in 1990 to $167 billion in 1996, down from the peak of $209 billion traded during 1994. These facts illustrate the growing competition between the U.S. and Latin American markets for trading volume in domestic equities.

With the altered choices for issuing equity, one should see the listing of a large number of companies following the internationalization of the market. After the listing of some of the larger firms, smaller firms should begin to raise more equity domestically and on international exchanges. This is what happened in the Mexican market. In both 1989 and 1990, less than $200 million in equity was raised in the stock market. The opening up of the stock market in May 1989 to foreign investors did not lead to an expansion in the placement of equity. However, after changes in regulations in the United States in 1990, relaxing requirements for equities traded in the private placement market and the international listing of Telefonos de Mexico in 1991, the placement of equity expanded dramatically.

In 1991, $5.1 billion was placed by Mexican companies, of which $3.7 billion was placed in international markets. During 1992, 21 companies raised equity worth $4.7 billion, including 10 international offerings of $3.0 billion. The number and value of domestic equity issues by Brazilian companies surged in 1994 to $2.8 billion, more than double the value of any year since 1986, while the value of Argentine domestic equity issued during 1993 increased to $1.1 billion, up from $116 million in 1990 before liberalization.

Many of the early offerings reflected the privatizations of previously state owned companies, such as Telmex. However, since 1992, many smaller firms have begun to list in the United States and domestically. In 1994, Grupo Modelo placed $530 million solely in the Mexican market, in contrast the usual one-third domestic, two-thirds international issues for many previous Mexican issues. This illustrates the expansion in offerings on the domestic market as well as in the international market.

The opening up of equity markets in Latin America to foreign investment has also induced a surge in prices across the region. Price/Earnings ratios have increased sharply after foreign investment restrictions were liberalized. In Mexico, the ratio increased from 4.6 before market opening in May 1989 to 17.1 at the end of 1994. The P/E ratio of the Brazilian market rose to 13.1 from 6.8 before liberalization in May 1991 while the Chilean market surged to a P/E of 21.4 from 3.9 in 1989. This could partially reflect the prospect of improved earnings after privatization and liberalization of these economies. However, infrequent trading, limited information and insufficient regulations in local equity markets may have been key factors in the depressed ratios prior to market opening.

The surge in prices after liberalization in Latin America should be expected if the markets moved from segmentation to integration. If integration is measured by the ability of investors in foreign markets to replicate the domestic market indices with internationally traded assets, these markets have moved from segmentation to integration. The trading of over 70% of the domestic market indices in the U.S. along with the expanding liquidity of Brady Bonds has enhanced the ability of these markets to be replicated with internationally tradable assets. Hargis (1997b) also demonstrates that in contrast to previous work showing an insignificant impact of the world market portfolio on returns in Latin America, the single factor International Capital Asset Pricing Model (ICAPM) is not able to be rejected after liberalization for Brazil or Argentina. In addition, the explanatory power of the model increases substantially after liberalization with the R-squared on the world market portfolio increasing from approximately zero to 13.4% and 4.1% for Argentina and Brazil respectively and from 6% to 12% in Mexico.

The benefits of moving from complete segmentation to integration increase when the correlations between stocks in the domestic market and international market are low and the correlations among individual stocks in the domestic market are high. For this reason, the growing integration of these markets should be more important than for developed markets because of the low correlations between emerging markets and developed markets and the high correlations among individual stocks in emerging markets. For the five year period ending in 1992, 13 of the 20 emerging markets followed by the International Finance Corporation (IFC) had a correlation coefficient of less than .2 with the United States,(12) while the correlations among individual equities within each market were higher than in the developed world. These correlations averaged 70% for all Mexican stocks compared to 49% in the United States.(13)

Internationalization should improve domestic market liquidity at the market and individual stock level. The increase in liquidity after liberalization as proxied by value traded or turnover at the market level in Mexico, Brazil, Argentina and Chile was demonstrated previously in Table 7. Hargis (1997c) also finds an improvement in domestic market liquidity following cross-listing of individual companies in the United States as measured by volume traded or sensitivity of absolute price movements to value traded. This occurs despite the fact that the U.S. market becomes the dominant market. The improvement in domestic market liquidity is greater for companies from countries with more restricted domestic equity markets and shares listed on a major exchange.(14)

Improvements in domestic market liquidity can reduce domestic market volatility after liberalization because of the reduced sensitivity of prices to surges in volume and more efficient aggregation of information. In contrast to the fears of policy makers, there is little evidence that investment liberalizations, foreign portfolio equity flows and foreign trading of domestic equities increases domestic stock market volatility. Bekaert and Harvey (1997) find a significant decline in volatility of emerging markets after liberalization, controlling for other time-series and cross-sectional factors affecting volatility. Volatility also declines significantly with indexes representing investment liberalizations, such as number of listed ADRs and country funds and percentage foreign ownership of the domestic market (Hargis, 1997b). The monthly standard deviation of the Argentine, Brazilian, Chilean and Mexican markets fell from 25%, 18%, 11% and 16% prior to liberalization to 11%, 15%, 8% and 11% respectively during the period after liberalization through June 1995 (including the period after the Mexican crisis). Hamao and Mei (1996) also find little empirical evidence that trading by foreign investors in the Japanese market increases volatility more than that of domestic investors.

Foreign participation has also increased the amount of information available for investors in emerging markets while the development of investment benchmarks by the International Finance Corporation has stimulated the use of passive investing in these markets. Before 1990, a large percentage of the equity was not traded and changes in prices were based largely on rumors, speculation and inside information. Therefore, brokerage research based on fundamentals was not in high demand and incentives to provide periodic financial reporting and accounting standards were not required of companies in many emerging markets. By listing in the United States, firms in Latin America must comply with all SEC regulations, including Generally Accepted Accounting Principles (GAAP).

The unfamiliarity of Mexican companies in dealing with foreign investors can be illustrated by the example of Cemex. When Cemex announced plans for using the proceeds raised from a previous equity offering in the purchase of a Spanish cement company, the price of the company's stock fell by 25% in a month. As a closely-held company, Cemex was not used to communicating company decisions to investors. Even though the acquisition was later viewed to be sound, it provided a lesson to Mexican companies about the need to communicate their intentions to international investors before raising funds.

The opening up of foreign investment banks in Latin American markets has aided the dissemination of information to potential investors in the United States and Europe. In 1988, Salomon Brothers formed a joint venture with Patrimonio in Brazil while Baring became the first foreign broker with a research office in Mexico during 1990. Since 1991, research and promotion of Latin American equities provided by these and other investment banks has been important in attracting foreign investors by informing potential investors about the investment opportunities.

Taken together, these studies indicate that foreign investment liberalizations have been beneficial for integrating emerging equity markets, improving liquidity, lowering volatility and enhancing the development of the domestic equity market.

VI. CONCLUSIONS

In the aftermath of the Mexican crisis, many policy makers have questioned the benefits of portfolio equity flows to emerging markets. However, an accumulating body of empirical evidence shows that liberalization of portfolio equity flows has been beneficial for stock market development, increasing prices and liquidity, and reducing volatility. The claim that the development of these markets will increase long-term economic growth is supported by empirical studies showing that stock market development is associated with future economic growth, independently of the development of the banking system.

Fears that a reversal of portfolio equity flows will increase the volatility of Latin American stock markets contrast with empirical evidence which shows that volatility in Brazil, Chile and Argentina during the year of the Mexican crisis were substantially below volatility prior to liberalization while Mexico received portfolio equity inflows during the first quarter of 1995 at the same time investors were liquidating their short-term portfolio debt holdings.

These facts point to the need to distinguish between different types of portfolio flows and to reexamine the belief that portfolio equity flows increase stock market volatility in Latin American stock markets.

NOTES

* Direct all correspondence to: Kent Hargis, University of South Carolina, International Business Program Area, CBA, Columbia, SC 29208.

1. This includes insurance companies, pension and mutual funds from the United States, United Kingdom, Germany, Japan, France and the Netherlands.

2. World Bank, Private Capital Flows to Developing Countries, p. 98.

3. Lipper Analytical Services.

4. World Bank, Private Capital Flows to Developing Countries, p. 106.

5. B shares were accessible to foreign investors while ownership of A shares was not allowed.

6. Bank of New York, 1996, The Complete Depositary Receipt Directory.

7. New ADRs can be created when existing shares in the domestic market are converted to ADRs trading in the U.S.

8. Bolsa Mexicana de Valores, Indicadores Bursatiles, various issues.

9. Value traded by Salomon Brothers is represented by Banco Patrimonio, 50% owned by Salomon Brothers, International Securities Regulation Report, April 25, 1996, p. 11.

10. Bovespa, Informe, various issues.

11. Euromoney, Guide to World Equity Markets 1994 and conversations with market participants.

12. Emerging Stock Markets Factbook (1993),

13. Monthly stock returns over the five-year period ending in 1991 (Divecha, Drach and Stefek, 1992).

14. These results are consistent with a study by Domowitz, Glen and Madhavan (1996) who find that although domestic spreads decline, liquidity also declines for Mexican cross-listed equities. First, most of their shares are traded over the counter and are not likely to have as large an impact as listed ADRs. Second, improvements in liquidity should be greater for countries such as Chile where foreign ownership restrictions are more important.

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Date:Sep 22, 1998
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