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Chapter Three
International Equity Markets

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 Chapter Outline
The World’s Equity Markets: A Statistical Perspective.
Market Structure, Trading Practices, and Costs.
Trading in International Equities.
International Equity Market Benchmarks.
iShares MSCI.
Factors Affecting International Equity Returns.

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 Market Capitalization
At year-end 2021, total market capitalization of the 80
organized stock exchanges tracked by the World Federation
of Exchanges (WFE) stood at $124,826 billion.
Five largest stock exchanges at end of 2021:
New York Stock Exchange (NYSE).
• NASDAQ.
• Euronext.
• Shanghai Stock Exchange.
• Japan Exchange Group.

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 Market Liquidity
A liquid stock market is one in which investors can buy and
sell stocks quickly at close to the current quoted prices.
• A measure of liquidity for a stock market is the turnover
ratio, calculated as the ratio of stock market transactions
over a period of time divided by the size, or market
capitalization, of the stock market.
• Generally, the higher the turnover ratio, the more liquid the
secondary stock market, indicating ease in trading.
• In 2021, many national stock exchanges had relatively high
turnover ratios, with close to 32% of the exchanges in
excess of 30% turnover on average.

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 Market Concentration
Investors would have difficulty diversifying their investments
in in stock markets dominated by a few large firms.
Concentrated financial markets also represent poor access of
firms to the stock market.
A common measure of stock market concentration is the ratio
of the market capitalization of the largest 10 companies
divided by the total market capitalization.
In 2021, the largest 10 companies on the Saudi Exchange
accounted for a whopping 87.81% of the total market
capitalization of the stock exchange.
The Japan Stock Exchange, on the contrary, had a much
lower concentration ratio of 17.82%.

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 Market Structure, Trading Practices, and
Costs 1

Secondary equity markets of the world serve two major

purposes:
1. Provide marketability.
2. Provide share valuation.
Investors who buy shares from the issuing firm in the primary
market may not want to hold them indefinitely.
The secondary market allows those share owners to reduce
holdings of unwanted shares and purchasers to acquire the
stock.

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 Market Structure, Trading Practices, and
Costs 2

When conducting a trade in the secondary market, public

buyers and sellers are represented by an agent, known as a
broker.
Order submitted to broker may be a market or limit order.
• Market order is executed at the best price available in the
market when the order is received, that is, the market
price.
• Limit order is an order away from the market price that is
held in a limit order book until it can be executed at the
desired price.

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 Market Order vs. Limit Order

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 Market Structure, Trading Practices, and
Costs 3

Secondary markets may have different designs that allow for

the efficient trading of shares.
Generally, a secondary market is structured as a dealer or
agency market.
• In a dealer market, the broker takes the trade through the
dealer, who participates in trades as a principal by buying
and selling the security for his own account.
• In an agency market, the broker takes the client’s order
through the agent, who matches it with another public
order.
Both dealer and agency structures exist in the United States.

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 Exhibit 13.3 Characteristics of Major
Equity Trading Systems
Market Characteristics
Equity Trading
System Public Orders Order Flow Example
Dealer Trade with dealer Continuous a
N ASDAQ/OTC
In the following table, read ‘system ’ as system superscript a.
Agency Agent assists with Continuous or NYSE specialist systema
matching of public periodic (continuous) Old Paris
orders Bourse (noncontinuous)

Fully automated Electronic matching Continuous Toronto Stock Exchange

of public orders

* As noted in the text, a specialist may at times also serve as a dealer.

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 Market Consolidations and Mergers
Western and Eastern Europe once had more than 20 national
stock exchanges where at least 15 different languages were
spoken.
Today, stock markets around the world are under pressure from
clients to combine or buy stakes in one another to trade shares of
companies anywhere, at a faster pace.
Many combinations and trading arrangements have been formed.
• For example, Euronext was formed in 2000 as a result of a
merge of the Amsterdam Exchange, Brussels Exchange, and
the Paris Bourse. Over the subsequent years, Lisbon Stock
Exchange, Irish Stock Exchange, and Oslo Børs merged with or
were acquired by Euronext.

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 Trading in International Equities
During the 1980s, world capital markets began a trend
toward greater global integration due to the following factors:
1. Investors began to realize the benefits of international
portfolio diversification.
2. Major capital markets became more liberalized.
3. New computer and communications technology facilitated
efficient and fair securities trading.
4. MNCs realized the benefits of sourcing new capital
internationally.

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 Cross-Listing of Shares 1

Cross-listing refers to a firm having its equity shares listed

on one or more foreign exchanges, in addition to the home
country stock exchange.
• Not a new concept, but amount of cross-listing has
exploded in recent years due to increased globalization.
• MNCs often cross-list their shares, but non-MNCs may
choose to cross-list as well.

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 Cross-Listing of Shares 2

A firm may cross-list shares for many reasons:

1. Expand the investor base for a firm’s stock, thus potentially
increasing its demand.
2. Establish name recognition of the company in a new capital
market.
3. Bring the firm’s name before more investor and consumer
groups.
4. Signal to investors that improved corporate governance is
forthcoming (if cross-listing into developed capital markets with
strict securities regulations and information disclosure
requirements).
5. May mitigate the possibility of a hostile takeover of the firm.

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 Cross-Listing of Chinese Firms
In the U.S., the listings of Chinese companies have occurred
in waves, starting in the 1990s following growing privatization
in China.
Listings of state-owned and large firms were later followed by
those of smaller Chinese firms, but a series of accounting
scandals plagued the latter firms. More than 100 Chinese
companies were delisted or suspended from trading on the N
YSE in 2011 and 2021.
IPO of Alibaba on the NYSE in 2014 revived cross-listings
from China.
China imposed stricter rules on Chinese firms listing abroad
in 2022.

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 Yankee Stock Offerings
Yankee stock offerings are sold directly to U.S. investors by
foreign companies.
Since the beginning of the 1990s, many foreign companies, have
listed their stocks on U.S. exchanges to prime the U.S. equity
market for future Yankee stock offerings.
For example, three factors appear to have fueled the sale of
Yankee stocks by Latin American firms:

1. Push for privatization by many Latin American and Eastern

European government-owned companies.
2. Rapid growth in economies of developing countries.
3. Large demand for new capital by Mexican companies following
approval of NAFTA.

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 American Depository Receipts 1

Foreign stocks can be traded directly on a national stock

market, but frequently they are traded in the form of a
depository receipt.
• Depository receipts (DR) market has grown significantly.
• In 2020 alone, $51.8 billion was raised through 134 DR
offerings.
An American Depository Receipt (ADR) is a receipt
representing a number of foreign shares that remain on
deposit with the U.S. depository’s custodian in the issuer’s
home market.
• According to the SEC, over 2,000 ADRs from over 70
countries are available in the U.S.
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 Advantages of ADRs 1

Investment advantages of ADRs include the following:

• ADRs are denominated in dollars, trade on a U.S.
exchange, and can be purchased through the investor’s
regular broker.
• Dividends received on the underlying shares are collected
and converted to dollars by the custodian.
• ADR trades clear in three business days, as do U.S.
equities.
• ADRs (except Rule 144A issues) are registered securities
that provide for the protection of ownership rights, whereas
most underlying stocks are bearer securities.

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 Advantages of ADRs 2

Investment advantages of ADRs include the following:

• An ADR investment can be sold by trading the depository
receipt to another investor in the U.S. stock market, or the
underlying shares can be sold in the local stock market.
• ADRs frequently represent a multiple of the underlying
shares, rather than a one-for-one correspondence, to allow
the ADR to trade in a price range customary for U.S.
investors.
• ADR holders give instructions to the depository bank as to
how to vote the rights associated with the underlying
shares.

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 American Depository Receipts 2

There are two types of ADRs:

Sponsored ADRs are created by a bank at the request of the
foreign company that issued the underlying security.
• Only type that can be listed on the U.S. stock markets.

Unsponsored ADRs were usually created at the request of a

U.S. investment banking firm without direct involvement by
the foreign issuing firm.
• Consequently, the foreign company may not provide
investment information or financial reports to the
depository on a regular basis or in a timely manner.

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 Exhibit 13.6 Types of ADRs
Exibit 13.6 Types of ADRs

LEVEL 1 LEVEL 2 LEVEL 3 RULE 144A

Description Unlisted program in Listed on a U.S. Shares offered and Private placement of
the U.S., and the exchange. The listed on a U.S. equity to Qualified
only program that issuer is not exchange. The Institutional Buyers
may be seeking to raise issuer floats a (QIBs). It can only be
unsponsored. The new capital. public offering of traded among QIBs.
issuer is not seeking new equity in the
to raise new capital. U.S. and lists the
ADRs.
Trading OTC NASDAQ, NYSE NASDAQ, NYSE U.S. private
placement
SEC Form F-6 Form F-6 Forms F-1, F-3, or None
Registration F-4
U.S. Reporting Exempt under Rule Form 20-F Form 20-F Exempt under Rule
Requirements 12g3-2(b) annually* annually* 12g3-2(b)

*Financial statements must be partially reconciled to U.S. GAAP.

Source: Excerpted from www.adr.com and the U.S. Securities and Exchange Commission.

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 Global Registered Shares
Merger of Daimler Benz AG and Chrysler Corporation in
November 1998 created DaimlerChrysler AG, a German firm.
Merger simultaneously created a new type of equity share, called
Global Registered Shares (GRSs).
• GRSs are traded globally, unlike ADRs.
• GRSs are fully fungible—a GRS purchased on one exchange
can be sold on another.
• Main advantages of GRSs over ADRs appear to be that all
shareholders have equal status and direct voting rights, while
main disadvantage of GRSs appears to be the greater expense
in establishing the global registrar and clearing facility.

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 International Equity Market Benchmarks

As a benchmark of activity or performance of a given national

equity market, an index of the stocks traded on the
secondary exchange (or exchanges) of a country is used.
• Indexes constructed and published by MSCI are an
excellent source of national stock market performance.
• MSCI presents return and price level data for 23 national
stock market indexes from developed countries, 25
emerging market countries, and 28 frontier markets that
cover investment opportunities beyond traditional
developed and emerging markets.

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 International Equity Market Benchmarks 2

MSCI also publishes a market-value-weighted World Index

representing large and mid-cap stocks across 23 developed
markets.
• Includes approximately 2,600 stock issues of major
corporations in the world.
MSCI publishes several regional indexes.
• The European, Australasia, Far East (EAFE) Index, the
North American Index, the Far East Index, several Europe
Indexes, the Nordic Countries Index, the Pacific Index, and
the Emerging Markets Index.

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 Factors Affecting International Equity
Returns
Which factors influence equity returns?
• Macroeconomic factors.
• Exchange rates.
• Industrial factors.
• Market factors.

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 Macroeconomic Factors
Many studies have tested the influence of various
macroeconomic variables on stock returns. For example:
• Hjalmarsson (2010) used over 20,000 monthly
observations from 40 countries and found that interest rate
variables can predict stock returns in developed markets.
• Atanasov (2021) found that a rise in the unemployment
rate relative to its trend predicts stock returns in the United
States and other developed markets.

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 Exchange Rates
Eun and Resnick (1988)
• Found that the cross-correlations among major stock
markets and foreign exchange markets are relatively low,
but positive.
Bartram and Bodnar (2012)
• Firms in emerging markets were affected by foreign
exchange rate risk to a greater extent than firms in
developed markets.
Dunne et al. (2010)
• Exchange rate, together with macroeconomic order flows,
can explain about 60 percent of the daily variation in the
S&P return and 40 percent of the CAC40 return fluctuations.
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 Industrial Factors
Much research has compared the explanatory power of
country versus industry factors in explaining foreign equity
returns.
In general, studies suggest that industry factors have
become more important in recent years.
• Phylaktis and Xia (2006) found that since 1999 there has
been a shift toward industry effects on international equity
returns. The degree of the shift varies across regions and
is more pronounced in Europe and North America,
whereas country effects dominate in Asia-Pacific and Latin
America.

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 Market Factors
Many studies examined the ability of market factors such as
size, value, and momentum to explain global stock returns.
In general, studies suggest that industry factors have
become more important in recent years.
• Fama and French (2012) found strong value premiums in
all regions studied and strong momentum returns in all
regions except Japan.
• Chaieb et al. (2021) found that factors such as market,
size, value, momentum, and profitability have higher
average returns. However, local factors, not world or global
factors, are still important.

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