Literature Review
Overview of the Impacts of Financial Liberalization on Stock Market
Financial liberalization refers to the process of removing restrictions on financial markets and institutions, encompassing a range of measures These include granting autonomy to the Central Bank from governmental influence, allowing unrestricted movement of capital in and out of the economy, and achieving full currency convertibility Additionally, it involves eliminating "priority sector" lending targets, discontinuing government-imposed differential interest rates, and allowing interest rates to be determined by market forces Financial liberalization also permits banks to operate profitably without government constraints, removes ownership restrictions on banks, facilitates foreign ownership, and abolishes "voting caps" on bank shares.
1.1.2 Some commitment of Vietnam when joining the WTO about market opening
The principle of "market opening," also known as "market access," involves allowing foreign goods, services, and investments into domestic markets In a multilateral trading system, the collective commitment of all parties to open their markets fosters the establishment of a globally integrated trading environment.
In the political realm, "market access" embodies the principle of trade liberalization established by the WTO Legally, it represents the binding obligations that a country commits to when it agrees to open its markets upon joining the WTO.
When Vietnam joined the World Trade Organization (WTO), it made significant commitments to open its markets across various sectors, including taxation, auditing, accounting, insurance, transportation, and stock markets This report specifically examines Vietnam's commitments regarding the stock market as part of its WTO accession.
Relating to securities services, Vietnam allows foreign investors to provide the following services:
We offer a range of transaction services for your account or your customers' accounts at the Stock Exchange, OTC, and other platforms Our services include derivatives, such as futures and options contracts, transferable securities, and various other financial assets, excluding physical gold.
These services encompass brokerage activities, including the issuance of various securities through underwriting and agency offerings, whether to the public or private sectors Additionally, they include asset management services such as portfolio management, collective investment management, pension fund management, and depository and trust services.
The payment services and securities clearing, the derivatives and other products relating to the securities
Provision and transfer of financial information, related software from provider of securities services
Vietnam allows foreign companies and investors to do securities activities in Vietnam at the following forms and conditions:
Representative office (provided that the agency do not do directly profitable business activities)
Joint ventures with Vietnamese partners (provided that the proportion of foreign capital contribution not exceeding 49%)
Since November 1, 2012, foreign enterprises can establish stock companies with 100% foreign capital Additionally, foreign securities companies have been permitted to open branches since the same date, although their operations are limited to providing asset management services, payment and securities clearing, as well as the provision and transfer of financial information and related software.
1.1.3 Impacts of financial liberalization on stock market
Here in this part, we just make some predicts about the impacts of Financial liberations on stock market according logical thinking.
Financial market innovations significantly enhance the long-term efficiency of the stock market, fostering increased lending and economic growth Additionally, the liberalization of financial markets has strengthened the role of equity markets in various countries, even establishing them in regions where they previously did not exist Research indicates that following financial liberalization, stock market volatility tends to decrease, supporting the notion that liberalization positively impacts market stability.
As financial restrictions are lifted and innovations are poorly managed, the newfound freedom may prompt financial institutions to engage in reckless lending practices, resulting in credit booms that can ultimately trigger financial crises.
Previous Studies on the Impacts of Financial Liberalization on Stock Market 11
Emerging markets exhibit distinct characteristics in their return distributions, including higher expected returns, increased volatility, and lower correlation with developed market returns Additionally, these markets demonstrate a greater degree of predictability compared to their developed counterparts.
Harvey (1995) and Claessens et al (1995) show that emerging market returns are more predictable than returns from mature markets.
Recent studies have investigated the effects of stock market liberalization on equity prices and the broader macro economy Henry (2000b) found that a country's aggregate equity price index experiences abnormal returns in the eight months leading up to the implementation of stock market reforms, indicating a revaluation of equity prices in anticipation of liberalization, even after accounting for macroeconomic reforms, privatization, and trade liberalization Bekaert and Harvey (2000) further noted that liberalization generally leads to a decrease in aggregate dividend yields, attributing this price change to a shift in the cost of capital rather than changes in firm earnings Additionally, Levine and Zervos (1998) highlighted that increased capital inflows can enhance stock market liquidity.
Research indicates that stock market liberalization significantly boosts physical investment and economic growth Henry (2000a) demonstrates that such liberalizations trigger investment booms in the years following the event, independent of global economic cycles and domestic factors This effect is attributed to a reduction in a country's cost of equity capital, which can convert previously unprofitable projects into profitable ones Additionally, Bekaert, Harvey, and Lundblad (2001) find that equity market liberalizations result in a one percent increase in annual real economic growth over five years, even when accounting for various standard economic growth determinants.
Schundeln and Funke (2001) shows that growth tends to be higher when the stock market liberalization is accompanied by institutional reforms Das and Mohapatra
(2000) show that the gains from increased growth are unequally distributed, accruing mostly to the top quintile of the population.
Recent studies by Kim and Singhal (2000) have highlighted the significant impact of stock market liberalization on market efficiency, demonstrating that stock markets tend to become more efficient following such liberalization events.
This paper analyzes variance ratios and employs nonparametric tests to investigate the unexplored causes of increased efficiency highlighted by Kim and Singhal (2000) In contrast to Kawakatsu and Morey (1999), who argue that liberalization has not enhanced market efficiency, our findings suggest otherwise Additionally, we address the lack of exploration into the factors influencing changes in efficiency.
Our Approach and Further Developments
Market efficiency is a fundamental concept in finance, defined by Fama (1991) as a market where asset prices reflect all available information Testing this theory poses challenges, as it involves a joint hypothesis concerning both market efficiency and specific asset pricing models A rejection of this joint hypothesis complicates the determination of whether market inefficiency or model specification issues are at play However, this paper will concentrate on evaluating relative market efficiency before and after liberalization, rather than assessing absolute efficiency at a single point in time, as noted by Campbell, Lo, and MacKinlay (1997).
‘notion of relative efficiency may be more a useful concept than absolute efficiency
Stock market liberalization enhances efficiency through various channels, often leading to increased liquidity, as evidenced by studies from Kim and Singhal (2000) and Levine and Zervos (1998) Emerging markets, typically characterized by low trading volumes, benefit from foreign entry and participation, which boosts liquidity and independently improves market efficiency While Kim and Singhal focus on the frequency of trading post-liberalization as a liquidity measure, this paper further explores the relationship between market efficiency and liquidity, an area previously overlooked.
Singhal According to a World Bank report (1997) shows that stock market capitalization and turnover increases more in countries that receive the higher levels of portfolio equity investments.
The influx of foreign investors into domestic stock markets is expected to enhance research on individual stocks and market conditions, resulting in better information accessibility for both foreign and domestic investors This trend suggests that foreign investors often demand greater transparency and stricter disclosure regulations, which ultimately contribute to more efficient capital allocation.
The liberalization of stock markets significantly enhances market efficiency by making them less predictable, which in turn promotes a more effective allocation of capital This study focuses on analyzing the effects of liberalization on liquidity and further explores how increased liquidity contributes to improved market efficiency.
The impact of equity market liberalizations on liquidity is a compelling area of study, with increasing research focusing on systemic liquidity Notably, Jones (2001) highlights that liquidity plays a crucial role in influencing conditional expected returns in the market, raising questions about whether liquidity is effectively priced.
The paper further presents evidence that liquidity (measured by bid-ask spread and turnover) predicts stock returns up to one year ahead.
This article explores the relationship between market efficiency and liquidity, highlighting the findings of Demirgüç-Kunt and Levine (1996) They suggest that with increased liquidity and the establishment of regulatory and legal frameworks, stock returns become less predictable, leading to greater market efficiency.
Market liquidity plays a crucial role in enhancing market efficiency, as highlighted by Muranaga and Shimizu (1999), who found that increased liquidity reduces market price uncertainties and liquidity premiums like bid-ask spreads Brown and Zhang (1997) further explore the relationship between liquidity and informational efficiency, revealing that a limit-order book system allows speculators to trade more aggressively on their information, ultimately lowering dealer profits while improving price informational efficiency Additionally, Easley and O’Hara (1993) investigate the influence of trading volume on the speed of price adjustments to new information, indicating that the efficiency of these adjustments varies significantly across different market structures, particularly in terms of liquidity.
Data and Methodology
Data Description
The data utilized in this analysis is sourced from Standard and Poor's Emerging Markets Data Base (EMDB), with returns derived from the local currency IFC Total Return Index, which encompasses dividends, stock splits, and capital gains To ensure relevance and accuracy, local currency returns are employed, thereby excluding exchange rate risk associated with US dollar currency returns.
However, conducting the analysis using the dollar returns does not change the nature of the results.
This study utilizes monthly data to address the challenges of non-synchronous and thin trading in Vietnam's stock markets, enhancing the reliability of the analysis.
Empirical Methodology
We test the following equation:
Liquidityt = αi + βLibt + Controlsi’tγ + ε it (Pooled OLS)
Liquidityt = αi + βLibt + Controlsi′tγ + ε it (Panel Estimation)
Liquidity is a crucial variable that assesses the liquidity of Vietnam's stock market This study employs various alternative measures of liquidity, including value traded in both local currency and US dollars, trading volume, turnover ratio, and the number of trading days Additionally, αi represents the country-specific effect in the analysis.
The Libt variable is a dummy variable if Vietnam is liberalized in time period t and zero otherwise
The Control variables include the growth rate of market capitalization of the firm and the growth rate of the local market index.
Tables 1 through 4 present the regression results, with the initial findings derived from pooled OLS analysis, followed by results from fixed effects and random effects panel estimation To assess the appropriateness of fixed versus random effects, the Hausman specification test was performed.
Table 1: Dependent variable: Value Traded in Millions of Local Currency
Table 2: Dependent variable: Turnover Ratio
Table 3: Dependent variable: Shares Traded
Table 4: Dependent variable: Days Traded
Empirical Results
Tables 1 to 4 present the regression results analyzing the effects of stock market liberalization on liquidity metrics The study controls for market capitalization growth and the local market index growth rate to assess size influences on liquidity Findings indicate that stock market liberalization significantly enhances liquidity, evidenced by increases in both the value and volume of shares traded, along with a higher turnover ratio.
The regression analysis in Table 1 reveals that the value traded in local currency serves as an effective measure of liquidity, demonstrating that liberalization positively and significantly impacts stock trading values Additionally, the regression results in Table 2, which utilize the turnover ratio as a liquidity measure, confirm that liberalization results in a notable increase in the turnover ratio.
The regression analysis reveals that liberalization significantly boosts both the number of shares traded and the number of days traded, indicating an increase in market liquidity Additionally, the findings suggest that higher trading volumes contribute to reduced inefficiency in stock markets, supporting the notion that enhanced liquidity can improve market efficiency.
Policy Implications of the Study Findings
Vietnam's Stock Market Situation After Liberalization
4.1.1 The situation after financial liberalization date
Following financial liberalization and Vietnam's accession to the WTO, the country emerged as a compelling investment destination, fostering intense market competition However, soaring inflation rates have adversely impacted business operations and production, leading to diminished appeal for stock market investors and a decline in overall market attractiveness.
Significant changes about stock market this period may include:
The recent promulgation of the Ordinance on Foreign Exchange has led to the full liberalization of transactions and a significant easing of capital transactions However, to maintain financial system stability and mitigate the risk of large-scale capital flight, capital flows continue to be closely monitored and regulated.
The credit activities changed from distribution to a small number of customers to the credit regardless of economic sectors; separate policy lending to commercial lending;
The provision of financial services for economic sectors and domestic and foreign financial institutions was expanded.
The evolution of payment systems and financial markets has significantly contributed to the liberalization and reform of the financial and banking sector, enhancing public confidence in the USD and the overall banking system.
There were many foreign securities companies in joint ventures with local partners These joint ventures, limited to a 49% stake, have been allowed since
In 2007, Vietnam's commitments to the WTO led to the licensing of various businesses, enabling securities companies to engage in activities like underwriting new securities issues, which necessitates a substantial capital base From 2000 to 2010, the number of total capital accounts opened by investors surged from nearly 3,000 to almost 1 million Despite this growth, the percentage of accounts remains low compared to Vietnam's population of 87 million, indicating significant future growth potential in the securities market.
Figure 1: Number of investor accounts as of 31 December (annually)
The number of listed companies has witnessed rapid growth HOSE and HNX listed approximately 548 companies at July 2010, 245 on HOSE and 303 on HNX.
Figure 2: Number of listed companies
Since 2007, the market capitalization of the HOSE has experienced significant growth Meanwhile, the HNX, which began operations in 2005, contributed approximately 20% to the combined market capitalization, reaching VND 650 trillion (US$ 33 billion) by July 2010, as illustrated in Figure 3.
This analysis compares stock returns during the average premarket liberalization and post-market liberalization periods, while also calculating returns that exclude data from one year before and after the market liberalization.
The analysis revealed substantial changes in stock returns surrounding the market liberalization date, with daily returns nearly doubling post-deregulation, followed by a decline in subsequent returns Excluding the year after liberalization, the mean return increased from 0.027 to 0.054, while the standard deviation indicated greater price volatility By removing data from 12 months before and after deregulation, the mean returns adjusted to 0.02 and 0.05, respectively, along with a similar decrease in standard deviation This data indicates a significant rise in stock prices and volatility within a two-year period centered on the liberalization event, aligning with existing literature that suggests equity prices typically surge after market liberalization Additionally, Henry (1998) noted that countries undergoing liberalization often see a revaluation of domestic stocks, reflecting lower equity capital costs, reinforcing the notion that equity increases coincide with reduced capital costs, leading to market stabilization post-liberalization.
4.1.2 Government policies issued during the period
Despite the State Bank's efforts to liberalize interest rates to attract capital, banks may face challenges when lending at rates that fall within the established fluctuation limits.
Strict regulation of interest rates and high entry barriers into financial markets are significant factors hindering the growth of Vietnam's financial system in recent years.
Next, although the exchange rates policy has been adjusted, recently Vietnamese currency has been appreciated, especially compared to other countries in the region.
This has limited the competitiveness of exports and done no good to the trade balance and current account balance The act of keeping exchange rate balanced is also difficult.
Currently, short-term capital flows into Vietnam are mainly through funds.
Investors must be convert currency to VND in order to insert new capital into funds.
This policy aims to control the amount of short-term capital and should be continued as the economy is unable to absorb capital well.
Despite high registered foreign direct investment (FDI) capital in Vietnam, the disbursement process has been sluggish, primarily due to procedural and systemic challenges This inefficiency not only wastes valuable time for investors but also poses risks that could undermine their confidence in the investment climate of Vietnam.
In 2007, although implementation reached nearly $8 billion, registered capital exceeded $ 21 billion In the first three months of the year, FDI reached U.S $ 5.4 billion capital but made only $2 billion.
Policy Implications
To establish a sustainable stock market, comprehensive reforms are essential, emphasizing transparency and adherence to international standards Monetary and fiscal policies significantly influence stock market dynamics, as adjustments in monetary policy can lead to substantial changes in market liquidity A minor intervention by the state bank can result in a sharp decline in the number and price of shares Therefore, restructuring the stock market is crucial to transform it into a long-term capital mobilization channel for businesses and an accessible funding source for both domestic and foreign investors The restructuring process must prioritize the stability of the financial system while ensuring efficient management and operation of the stock market.
4.2.2 Produce high quality products for the market
To enhance the quality of products available on the stock market, it is essential to continue the privatization process in Vietnam This will create attractive opportunities for both domestic and foreign investors to acquire new shares in Vietnamese companies through various methods, including auctions Strengthening financial capabilities and management practices is a key objective Moreover, foreign investment in commercial banks will address existing weaknesses in financial resources and technology, fostering overall growth in the sector.
To boost the financial capacity of banks and firms post-privatization, the government should strategically increase the capital threshold for foreign investors in commercial banks to a maximum of 30% This move will enhance the appeal of the firm's shares, making them more attractive to potential investors.
4.2.3 Complete the legal documents and policies mechanisms for the development of the Vietnam’s stock market
Consider, amend and add suitable articles to the Law of Securities by expanding the scope of the law to fit the trend of economic integration.
Issue guidelines on a number of Securities transactions, such as short- selling transactions, borrowing and lending of securities transactions, derivative transactions and transfer transaction of founding shareholders.
Consider the tax policy to ensure the sustainable development of the stock market (In the context of economic recession, consumer’s demand decline …).
Coordinating monetary and fiscal policies is essential for fostering stock market development, as monetary policy aims to stabilize the monetary environment while fiscal policy seeks transparency, stability in output, and effective resource allocation The interplay between these two policies significantly influences the economy and financial markets; poor fiscal management can lead to rising inflation expectations, which may increase money supply and interest rates, adversely affecting government debt securities Conversely, high inflation and rising interest rates can diminish government revenue and contribute to stock price volatility, discouraging market investment Therefore, a comprehensive understanding of the relationship between monetary and fiscal policies is crucial to enhance their alignment and minimize conflicts, ultimately achieving desired economic objectives.
Since Vietnam's accession to the World Trade Organization, financial liberalization has accelerated significantly This study specifically examines the effects of financial liberalization on Vietnam's stock market, utilizing data collection and model analysis The findings reveal several key insights that differentiate this research from previous studies on the topic.
Limited empirical research has explored the impact of financial liberalization on stock market liquidity and efficiency, particularly in the context of Vietnam's stock market This study addresses this significant gap in the literature by providing insights into these effects.
Our analysis highlights the beneficial impact of financial liberalization on Vietnam's stock market through quantitative modeling Based on our significant findings, we recommend several policies aimed at assisting managers in effectively capitalizing on the opportunities presented by financial liberalization, ultimately fostering a stock market characterized by enhanced liquidity and efficiency in this liberalized environment.
The study is limited by the use of a monthly dataset, which results in missing values due to insufficient information Additionally, discrepancies arise from collecting data across various sources that employ different definitions, criteria, and calculation methods, potentially leading to errors in the results Furthermore, the models overlook critical factors such as macroeconomic conditions, political measures, and investment risks, which theoretical studies suggest could significantly impact the findings.
Because of limitation of time and knowledge, we have not reviewed so many previous studies to have strong theoretical framework for our research.
If our time is more flexible, we will develop this study and overcome the limitation to make it more perfect, such as:
To create a comprehensive and current database of raw materials, it is essential to systematically compile and evaluate sources Prioritize the quality of these sources and select the most relevant ones to develop an optimal database that supports in-depth research.
Search and read more literature about our topic to see how scholars and researchers study this, then we can make a stronger theoretical basis for further study.
To enhance model development in this area, it is essential to incorporate additional variables that reflect the various aspects of macroeconomics and management within our country Additionally, examining factors related to international economic integration will help assess their influence on the liquidity and efficiency of the stock market.
Research indicates that financial liberalization has positively impacted Vietnam's stock market, making it a compelling investment destination with heightened competition Key changes include fully liberalized transactions, eased capital movements, a shift in credit activities towards a smaller customer base, increased commercial lending, and expanded financial services for various economic sectors and institutions Additionally, the development of payment systems and financial markets has occurred, alongside a growing public confidence in the USD and the banking system.
Financial liberalization has significant impacts, presenting both opportunities and challenges We recommend that the government implement strategies to effectively leverage these benefits while addressing potential issues This study highlights the importance of a deeper exploration into the effects of financial liberalization, making it a valuable contribution to the current discourse.
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