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Extreme events – global stock market differences revealed

9 December 2014

Stock markets around the world function in dramatically different ways when businesses first publicly sell shares, according to new research by Abertay University and Capco.

The first public sale of shares on a stock market – a process known as an initial public offering (IPO) – involves a price being selected based on the company’s likely value and estimated demand for its shares.

The difference between the initial price and the price at the end of the first day’s trading establishes the level of under-pricing or over-pricing. Shares at IPO are usually under-priced to compensate for uncertainty about commercial interest in the company.

China sees under-pricing of over 160% on the first day’s trading, compared to around 100% in India and just 4% in Russia. The UK and the USA, being the largest financial markets in the world, set the ‘efficient markets’ standard with almost identical under-pricing at about 17%.

The likelihood of ‘extreme events’, where a company’s share price changes dramatically in a short period of time, was proven to be much more likely in Asia’s financial markets than in Europe’s.

This new research was conducted by Professor Gavin Reid, Head of Dundee Business School at Abertay University, and Dr Morten Dyrmose, an Associate of Capco, a leading global business and technology consultancy that focuses exclusively on financial services, which publishes a house journal, the Journal of Financial Transformation, in which this research appears.

Professor Gavin Reid said: “Our research looked at the inefficiencies in the IPO market, which is particularly interesting to high-tech companies looking to raise additional capital through a first public sale of shares.

“Under-pricing can also contribute to volatility within stock markets. It may attract investors with an appetite for risk in pursuit of large gains, but there is cause for concern about inefficient stock markets – possibly combined with inadequate regulation and underdeveloped financial institutions – being harmful to a country or a region’s longer term economic prospects.”

A high level of under-pricing can be a sign of a volatile investment environment, with investors rushing in to new companies – and potentially quickly selling other shares to do so. Volatility can itself become a major drag on stable, sustainable economic growth.

Professor Reid added: “People may look conventionally at markets like China and Russia as having many similarities in terms of their histories and levels of state involvement in their economies, but our research shows great differences in the accuracy of share price predictions between the countries – which provides a kind of ‘barometer’ of economic atmosphere, indicating the diverse paths to maturity of these economies.”

Rob Hayvaert, the CEO of Capco, said of its Journal that it aims to “build a bridge between academia and the financial services industry, creating a space where the best work of both worlds can share cutting edge ideas that are shaping the world in which we live”, an ambition that fits well with the strategy of the Dundee Business School.

The full study is available from the Capco Institute’s Journal of Financial Transformation.


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