Risk Management in Emerging Markets
Centre for the Study of Emerging Markets Series Series Editor: Dr Sima Motamen-Samadian The Centre for the Study of Emerging Markets (CSEM) Series provides a forum for assessing various aspects of emerging markets. The series includes the latest theoretical and empirical studies from both academics and practitioners in relation to the economies and financial markets of emerging markets. These cover a wide range of subjects, including stock markets and their efficiency in emerging markets, forecasting models and their level of accuracy in emerging markets, dynamic models and their application in emerging markets, sovereign debt and its implications, exchange rate regimes and their merits, risk management in emerging markets, derivative markets and hedging decisions in emerging markets, governance and risk in emerging markets, etc. The series will be one of the main sources of reference on emerging markets, both within and outside those markets, for academics, national and international agencies, and financial institutions. Titles include Sima Motamen-Samadian (editor) CAPITAL FLOWS AND FOREIGN DIRECT INVESTMENTS IN EMERGING MARKETS DYNAMIC MODELS AND THEIR APPLICATIONS IN EMERGING MARKETS RISK MANAGEMENT IN EMERGING MARKETS GOVERNANCE AND RISK IN EMERGING AND GLOBAL MARKETS Also by Sima Motamen-Samadian INTERNATIONAL DEBT AND CENTRAL BANKING IN THE 1980s (edited with Z. Res) EMERGING MARKETS Past and Present Experiences, and Future Prospects (edited with C. Garido) Centre for the Study of Emerging Markets Series Series Standing Order ISBN 1 4039 9521 4 You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England
Risk Management in Emerging Markets Edited by Sima Motamen-Samadian
Selection and editorial matter Sima Motamen-Samadian 2005 Individual chapters contributors 2005 Softcover reprint of the hardcover 1st edition 2005 978-1-4039-9153-9 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published in 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world. PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin s Press, LLC and of Palgrave Macmillan Ltd. Macmillan is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 978-1-349-54286-4 ISBN 978-0-230-59636-8 (ebook) DOI 10.1057/9780230596368 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Risk management in emerging markets / [edited] by Sima Motamen-Samadian. p. cm. (Centre for the Study of Emerging Markets series) Includes bibliographical references and index. 1. Risk management Developing countries. 2. Securities Developing countries. 3. Asset-liability management Developing countries. I. Motamen-Samadian, Sima. II. Series. HG5993.R57 2005 332.67 3 091724 dc22 2005047311
Contents List of Figures and Tables Preface Acknowledgements Notes on the Contributors vii xi xiii xv 1 Introduction 1 Sima Motamen-Samadian 2 Risky Production and Hedging in Emerging Markets 5 Octave Jokung 3 An Analytical Study of Option Greeks on Derivative Markets in India 17 Devendra G. Kodwani 4 Global Asset Allocation: Risk and Return Trade-off on Emerging Stockmarkets 35 Mohamed Derrabi and Michel Leseure 5 Random Walk in Emerging Markets: A Case Study of the Karachi Stock Exchange 57 Orla Gough and Ali Malik 6 Insiders Market Timing and Real Activity: Evidence From an Emerging Market 71 Tomasz Piotr Wisniewski v
vi Contents 7 Trading Risk Management: Practical Applications to Emerging Markets 91 Mazin A.M. Al Janabi 8 Value at Risk: Does it Work in Emerging Markets? 137 Chuntao Yu, Bob Davidson and Mohamed Nurullah Index 165
List of Figures and Tables Figures 3.1 Daily average turnover in the derivatives segment of the National Stock Exchange, India 18 3.2 Growth in the derivatives segment of the National Stock Exchange, India 18 3.3 Actual and theoretical premiums on Nifty index calls 25 3.4 Implied volatility on index call option expiring 30 August 2001, K = 1,180 30 3.5 Implied volatility on index call option expiring 28 March 2002, K = 1,180 30 4.1 The efficient frontier based on the weekly indices of emerging markets and developed markets 46 6.1 Orthogonized impulse responses of variables to shocks in equations 82 8.1 Selecting models for normal market risk 159 8.2 Selecting models for abnormal market risk 160 Tables 3.1 Historical volatility estimates of the underlying index 22 3.2 91-day Government of India treasury bill yields 23 3.3 Expiry dates and exercise prices on Nifty Index options used in this study 23 3.4 Option Greeks: equations used for calculations on call options 24 3.5 Call premiums, volatilities and option Greeks on nifty index call options 26 3.6 Delta estimates and the likelihood of index call options being in-the-money on expiration 32 4.1 Analysis of the stock exchange markets of the sample 42 4.2 Coefficients of correlation between stockmarkets 45 4.3 Application of the global market model to emerging and industrialized markets 50 vii
viii List of Figures and Tables 5.1 Results of the Dickey Fuller unit-root test 66 5.2 Results of the autocorrelation test 66 5.3 Results of the day-of-the-week effect 67 6.1 Descriptive statistics 75 6.2 Granger causality tests 80 6.3 Three-variable innovation accounting 84 7.1 Quantitative analysis data: daily volatility, beta, skewness and kurtosis 113 7.2 Quantitative analysis data: annual volatility, beta, skewness and kurtosis 114 7.3 Quantitative analysis data: exact correlation matrix 115 7.4 Quantitative analysis data: correlation 1 matrix 116 7.5 Quantitative analysis data: correlation 0 matrix 117 7.6 Equity trading risk management report (analysis of case 1) 119 7.7 Equity trading risk management report (analysis of case 2) 121 7.8 Equity trading risk management report (analysis of case 3) 122 7.9 Equity trading risk management report (analysis of case 4) 123 7.10 Equity trading risk management report (analysis of case 5) 124 7.11 Equity trading risk management report (analysis of case 6) 125 7.12 Equity trading risk management report (analysis of case 7) 127 7.13 Equity trading risk management report (analysis of case 8) 128 7.14 Equity trading risk management report (VaR limits-settings, case 1) 129 7.15 Equity trading risk management report (VaR limits-settings, case 2) 130 7.16 Equity trading risk management report (VaR limits-settings, case 3) 131 7.17 Equity trading risk management report (VaR limits-settings, case 4) 132 8.1 A brief summary of current market-risk measures 138 8.2 An overview of the three main VaR methodologies 140
List of Figures and Tables ix 8.3 A summary of the key strengths and weaknesses of three VaR methodologies 141 8.4 Responses to question 1 143 8.5 Responses to question 2 143 8.6 Responses to question 3 144 8.7 Responses to question 4 145 8.8 Responses to question 5 146 8.9 Responses to question 6 146 8.10 Statistical results of questions 7 and 8 147 8.11 Statistical results of Q9 149 8.12 Responses to question 10 150 8.13 Responses to question 11 151 8.14 Responses to question 12 151 8.15 Responses to question 13 152 8.16 Responses to question 14 152 8.17 Responses to question 15 153 8.18 Responses to question 16 153
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Preface The eight studies presented in this volume are put together to provide a new insight into the design of risk-management models in emerging markets. The objective is to identify the specific characteristics of emerging markets and specify the most appropriate methods of risk management that suits those markets. The chapters report on empirical studies carried out on a number of countries in Asia, Eastern Europe, North Africa and other emerging markets in various continents. They present the latest findings that are important for better understanding of the nature of risks in those markets, and useful to all those involved in decision-making for investment in emerging markets. Chapter 2 looks at hedging decisions in the presence of price and political risks in emerging markets. Chapter 3 examines the volatility of the index and security-based options in India s derivative market. Chapter 4 is about asset allocation in both emerging and developed economies, and the extent to which inclusion of emerging markets in a portfolio can affect the overall risk and return of the portfolio. Chapter 5 tests the efficiency of the Karachi Stock Exchange, and Chapter 6 discusses the extent of aggregate insider trading in the Polish stockmarket and the way it affects the market and the economy. Chapter 7 analyses the problems of trading risk management in emerging markets and focuses on the Moroccan stockmarket. Chapter 9 evaluates the applicability of Value at Risk models in emerging economies and offers some new ideas on how the model can be improved to fit emerging markets. Overall the book provides a good coverage of the latest findings about risk management in a diverse range of emerging markets across the world. SIMA MOTAMEN-SAMADIAN xi
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Acknowledgements This volume is a collection of some of the papers that were presented at the International Conference on Emerging Markets and Global Risk Management in June 2004 in London. The conference was organized by the Centre for the Study of Emerging Markets (CSEM) at the Westminster Business School. My special thanks go to all the contributors for their timely delivery of the chapters, and to my family and in particular my husband Vahab Samadian for his continuous support through the period when I was working on the book. SIMA MOTAMEN-SAMADIAN xiii
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Notes on the Contributors Mazin A.M. Al Janabi is an Associate Professor of Finance and Banking at the School of Business Administration, Al Akhawayn University, Ifrane (AUI), Morocco. Bob Davidson is a Principal Lecturer in Finance in the Division of Risk, Caledonian Business School, United Kingdom. Mohammed Derrabi is an Associate Professor at the School of Business Administration, Al-Akhawayn University in Ifrane, Morocco. Orla Gough is Chair of the Department of Finance and Business Law at the Westminster Business School, University of Westminster, United Kingdom. Octave Jokung is Associate Professor at the Edhec Business School, Lille, France. Devendra G. Kodwani is a Lecturer in Finance at the Open University Business School, Milton Keynes, United Kingdom. Michel Leseure is a Lecturer in Technology and Operations Management, Aston Business School, Aston University, United Kingdom. Ali Malik is a Visiting Lecturer at the Westminster Business School, University of Westminster, United Kingdom. Sima Motamen-Samadian is Director of the Centre for the Study of Emerging Markets and a Principal Lecturer in Economics at the Westminster Business School, University of Westminster, United Kingdom. Mohamed Nurullah is a Lecturer in the Division of Risk, Caledonian Business School, United Kingdom. Tomasz P. Winsiewski is a Senior Lecturer in Finance at the Department of Finance, Auckland University of Technology, New Zealand. Chuntao Yu is a Consultant at Price Waterhouse Coopers, China. xv