Ajekwe et al. 2017 testing the random walk theory in the nigerian stock market
The Performance of the Egyptian Stock Market_Bassam Azab
1. Page 1
The Performance of the Egyptian Stock Market
Bassam I. Azab
Submitted in part fulfilment of the degree of Master of Business Administration,
International Banking and Finance
The University of Birmingham
The Birmingham Business School
September 2002
2. Page 2
Acknowledgements
I would like to express my sincere gratitude to the following for their assistance
during the course of this study. Dr. John P. Cadle, my supervisor for his support
during the data collection process and for his academic views and comments during
the entire project and Professor Andrew W. Mullineux, Head of Master of Business
Administration, International Banking and Finance, The University of Birmingham
for his comments during the planning stage of this project.
I would like to thank the following for their valuable assistance during data collection,
which was of significant effect on the successful completion of this project. Dr.
Shahira Abdel Shahid, Director of Research & Markets Development, Cairo and
Alexandria Stock Exchanges. Khaled El Mahdy, Head of Research, HSBC
Investment Bank-Egypt. Amr A. Abol-Enein, Vice President and Head of Equity
Research, HC Brokerage. Hisham Hassan, General Manager, Prime Group. Georges
Cattan, Head of Custody and Clearing, HSBC Bank-Egypt. Yosra Fatin, Senior
Analyst, Research Department, HC Brokerage. Nirvana R. El Sherbiny, Supervisor
Custody and Clearing, HSBC Bank-Egypt and Wael I. Azab, Shawky and co.
I would like also to thank Jonathan A. Divis, General Manager, Operations and
Finance, HSBC Bank-Egypt for all his support, which led, eventually, to the
production of this work.
Finally, I would like to express my deep gratitude to the lady that was the reason
behind this work and all what I have managed to achieve so far, my mother. To her
and to my family I would like to say thank you.
To all the above, I would like to say Thank you for that, without your assistance and
support, the production of this work could not be possible.
3. Page 3
Synopsis
Emerging markets are generally characterised by being “informationally inefficient”,
which might indicate the existence of mispricing opportunities that justify the
activities of active fund management to achieve abnormal returns within these
markets.
The aims of this project were, first, to explore the effect of information on the
performance of the stock market in Egypt in accordance with the Efficient Market
Hypothesis, as suggested by Fama (1970) and others, and, then, to assess whether
mutual funds in Egypt were able to adopt strategies that outperformed a passive
strategy.
To achieve these objectives, first, Event Studies were utilised to examine the
behaviour of stock returns around the announcement date of a number of corporate
actions including dividend distributions and acquisitions during the period 2000/2001.
Then, CAPM based Performance Evaluation measures were utilised to assess the
performance of a sample of mutual funds in the Egyptian market during the period
from the beginning of 1998 until the end of 2001.
The tests for market efficiency showed a departure from the “Semi-Strong from”
efficient markets indicating that publicly available information might have not been
“fully reflected” in securities prices and suggesting the existence of mispricing
opportunities that could have been used to achieve abnormal returns.
The tests for the performance of mutual funds showed that, despite the findings of the
tests for market efficiency, mutual funds in Egypt were unable to outperform a
passive market strategy.
4. Page 4
Chapter 1 Introduction
Emerging markets are generally characterised by being inefficient due to their recent
history. This characterisation provides a number of perils and rewards to investors in
such markets.
Recent research, however, has shown many attractive rewards that, on the aggregate,
tend to over weigh the perils.
In this project, an attempt is made to explore the validity of the above statement by
modelling one of the new emerging markets that showed investment potential in the
Middle East and North Africa (MENA) region in the past few years.
The project attempts to investigate the degree of efficiency of the Egyptian market by
examining the effect of publicly available information on the performance of the
Egyptian stocks and whether profitable opportunities might exist to justify active fund
management activities.
The project, then, concludes by examining whether Egyptian mutual funds were able
to locate and benefit from these opportunities.
1.1. Aims and Objectives
Under the Efficient Markets Hypothesis, stock prices are assumed to “Fully Reflect” a
set of information so that, it becomes very difficult to gain abnormal returns by
trading on this set of information.
In this project, efficiency of the Egyptian market is examined with respect to the set of
publicly available information about the particular stocks analysed to see whether
5. Page 5
stocks fully reflect the set of information, in the determination of their fair values, or
if mispricing opportunities exist and could be exploited to achieve abnormal returns.
The test is, then, directed to examining the performance of a sample of Egyptian
mutual funds to see whether they were successful in locating and profiting from
mispricing opportunities in the from of abnormal returns.
To achieve the above objectives, Event Studies, as suggested by Fama, Fisher, Jensen
and Roll (1969) are, first, utilised to examine the behaviour of stock returns around
the announcement date of various corporate actions (Dividend Distributions and
Acquisitions) during the years 2000/2001 to examine the effect of surprise, in the
form of new information, and the speed with which stock returns adjust to reflect the
new fair value of the stock.
Capital Asset Pricing Model (CAPM) based evaluation measures, as suggested by
Jensen (1968), Treynor (1965), Sharpe (1966) and Treynor and Black (1973) are,
then, utilised to evaluate the performance of a sample of mutual funds for the period
1998-2001 to assess their success in locating and profiting from mispricing
opportunities within the Egyptian market.
1.2. Project Structure
The project is structured in the following sequence:
Chapter 1 provides a general background, the Aims and Objectives of the project and
the Structure of the project.
Chapter 2 surveys the literature about Emerging Markets and Market Efficiency and
concludes by a study about the efficiency of the Egyptian market that was conducted
by the International Monetary Fund (IMF) in 1999 to test the Weak-form Efficiency
of the Egyptian market.
6. Page 6
Chapter 3 provides a general preview about the Egyptian stock market including
Regulatory Framework, the Stock Exchange, Indices, Key Economic Sectors, Market
Participants and Instruments. The chapter concludes by an evaluation of the overall
performance of the market during the period 1996-2001.
Chapter 4 tests for Semi-strong market efficiency and is organised by, first,
identifying the Methodology of the tests, second, defining the Data set used and,
finally, providing the Findings of the tests of the behaviour of stock returns around the
announcement dates of a number of corporate actions (Dividend Distributions and
Acquisitions) that took place during the years 2000/2001.
Chapter 5 tests for mutual funds performance, and is organised, in a similar style to
that of chapter 4, by, first identifying the Methodology of the tests, second, defining
the Data set used and, finally, providing the Findings of the tests of mutual funds
performance during the period 1998-2001.
Chapter 6 concludes by summarising the Objectives and Procedures of the project,
providing the overall Findings and Conclusions about Market efficiency and mutual
funds performance, explaining the Limitations on the tests conducted, listing the
Recommendations based on findings and, finally, making Suggestions for Further
Research.
7. Page 7
Chapter 2 Literature Review
2.1. Emerging Markets
It is usually difficult to classify markets into mature or emerging as there are no clear
dividing lines and grey areas always exist.
However, International Finance Corporation adopts two criteria to include countries
in its Emerging Markets Data Base (Solnik, 2000). These two criteria are:
• A country with low or middle income using the World Bank’s
Classification;
• A stock market that has shown the promise of becoming mature.
In his research, Solnik (2000) identifies the attractive attributes of Emerging Markets
as being of High Potential Growth and Low Correlation with developed markets. The
main concern that he identifies in his study is the relatively high volatility of
Emerging Markets when compared with Developed Markets.
In commenting on this concern, he draws attention to the fact that from a Portfolio
diversification point of view, the inclusion of Emerging Markets into the investment
portfolio provides a more efficient utilisation of the funds invested in terms of higher
returns for the same level of risk.
To substantiate his view, he includes the results of a study of the Efficient Frontiers
for global asset allocation with and without Emerging Stock Markets for a Swiss
Pension Fund (Odier, Solnik and Zucchinetti, 1995).
Graph (2.1) below depicts the results of the study.
8. Page 8
Graph 2.1. Efficient Frontier with Emerging Markets
Source: Odier, Solnik, and Zucchinetti, “Global Optimisation for Swiss Pension funds”, 1995 in Solnik,
“Investments”, 2000
From the graph, it can be seen that with a portfolio of 19% volatility, investment
solely in the Swiss stock market had a return of 11.5%; adding investments in
Developed markets only gave a return of 19% while the return increased to 28% when
both Developed and Emerging markets were included in the optimal portfolio.
In addition, Solnik (2000) details a number of benefits and concerns from an
international investor’s perspective with respect to investing in Emerging Markets.
The benefits listed include the interest of Institutional Investors in Emerging markets
interpreted in the form of professional studies, indices and better channelling of funds
for the best performing markets.
Economic benefits are another attractive factor in the form of lower labour costs,
lower levels of unionisation, social rigidities and rapid growth in domestic demand.
9. Page 9
Political reform in many developing countries provides another factor why Emerging
markets are becoming more attractive. With the fall of communism in Central and
Eastern Europe, and the political reform in China, many developing countries are
adopting the model of a more free and open economy.
In his list of concerns, Solnik (2000) mentions concerns about Political and Social
Stability in developing countries. The highly diverse nature of Emerging Markets with
little correlation between them is another concern, which may lead to marked
differences in the performance of international indices. The availability of quality and
timely information is a very important concern with many Emerging markets lacking
reliable accounting and reporting standards. This is not to mention the lack of
harmony among those countries’ systems, which necessitates great effort to readjust
and harmonise if useful investment information is to be obtained.
Other concerns include the highly illiquid nature of emerging stock markets, since
trading in many of these markets is concentrated in a small number of stocks with
higher trading costs associated.
Two final concerns are the National Regulations and Controls, in the form of imposed
restrictions on foreign investment either on entry or exit, and the limited availability
of efficient Country Funds that can provide better specialisation and access to
Emerging markets for international investors.
Howell, Claessens and Gooptu (1994) go further by listing the benefits and concerns
for both countries and investors.
They suggest that, for Developing countries, the benefits of foreign investment flows
may be:
10. Page 10
• More diversified sources of external finance;
• Greater risk bearing by private investors through equity investment,
compared to the case of bank lending in the 1970s;
• Reduced cost of capital;
• Better management of invested funds under the private-to-private flows.
They also suggest that the main concern of developing countries is that increased
capital inflows may lead to an appreciation of the real exchange rate, which may lead
to a bigger non-tradable sector, and a smaller tradable sector, and, eventually, to a
larger trade deficit.
They argue, however, that to overcome this problem, countries should rely on
sustained domestic economic reform. This comes in the form of a sound financial
system that properly channels inflows to the most appropriate uses.
They also list the benefits to investors from investing in Emerging markets as
including:
• Favourable interest and equity return differentials with industrial countries;
• Risk Diversification due to low correlation of stock returns in
developing countries with returns in industrial countries.
• The inefficiency of Emerging markets, which makes returns predictable;
• New channel for directing the continued domestic savings of industrial
countries.
In a manner similar to Solnik (2000), Howell et al. (1994) list concerns to investors as
being legal investment restrictions in the country of investment, poor credit ratings of
both the countries and the companies within, high and variable inflation, limited
market size, absence of solid regulatory and accounting framework and investor
11. Page 11
protection, inefficient country funds and limited number of internationally listed
securities.
Williamson (1993) discusses the issue of better fund management under the private-
to-private flows and poses the question of whether foreign equity investment in
Emerging markets will necessarily lead to an increase in real investment in the private
sector.
He argues that most equity purchases are effected on the secondary rather than the
primary market. This has the impact of increasing share prices rather than increasing
investment flows to companies. Hence, the direct impact of increased flows may be
seen as increased wealth for investors in the secondary market, thereby increasing
consumption expenditure without an immediate benefit to the economy unlike the
impact a Foreign Direct Investment (FDI) might have.
However, he acknowledges the fact that with the continuing inflows of investment
funds to Emerging markets, a form of correction may take place in the shape of
increased investment due, perhaps, to sellers’ decision to invest the excess profits in
under-priced assets.
In a similar manner, Howell et al. (1994) present a Two-phase development of
emerging markets. In the first phase, which they designate “Indiscriminate Capital
Flows”, the prices of all assets rise due to the injection of foreign capital.
However, in the second phase, foreign investors start to search for genuine growth
industries in a manner that makes their buying behaviour introduces clear sectoral
patterns both between Emerging markets and within individual Emerging markets.
12. Page 12
From the above Two-phase process described by Howell et al. (1994), it may be
inferred that the wealth of investors in the secondary market may increase in a manner
consistent with Williamson’s views (1993) leading to increased consumption
expenditure.
However, the correction process should come in the second phase leading to an
effective channelling of foreign investment inflows to the benefit of the countries
involved.
Claessens (1993) presents another interesting barrier to investment in developing
countries; that is the restrictions, regulatory and accounting standards imposed on
investors in the home country. He explains that even if the country of investment has
no restrictions or barriers to the free flow of foreign funds, still any barriers, whether
regulatory or financial, imposed on investors in home country may prevent the free
flow of funds, for example, a ceiling on the investment in specific country’s market or
securities.
Claessens (1993) also discusses the concept of markets’ integration and explains that
integration moves in a reverse direction with diversification.
That is, if markets are fully integrated with each other, then the risk premiums will be
equal across markets and, hence, there will be no benefit from diversification.
He also explains that market integration is closely related to the level of barriers in the
market considered. So, the higher the barriers, the lower the market integration and
the higher the benefit of diversification.
From this argument, it may be inferred that the higher diversification benefit to
international portfolios, which is attributed to the low correlation between Emerging
markets and Mature markets, stems from the higher barriers to the free flow of funds
13. Page 13
and may explain the recent increase in correlation between the performance of
Emerging markets and Mature markets. That is, with the continuing lowering of
barriers in Emerging markets, markets are getting closer to full integration with
developed markets and, hence, the diversification benefit from investing in those
markets diminishes.
Claessens (1993) also discusses another consequence of the existence of barriers in
Developing countries. That is, the security design which dictates how foreigners may
enter a specific market.
He depicts a typical case of a newly opened market to foreign investment where
access is initially restricted to specific types of instruments, Country Funds, etc.,
before direct and complete access is allowed to foreigners.
On the basis of this notion, he stresses the importance of proper security design,
which enables foreigners to access Emerging markets, whether under the conditions
of restricted access or free access to achieve the maximum benefit from investment.
He suggests three important factors to consider when designing the appropriate
securities. These are the degree of asymmetry of information about the specific
country or firm, characteristics of the borrowing firm and the depth and completeness
of securities markets.
Harvey (1993) examines another dimension of Emerging markets, the high volatility
exhibited by the markets of Developing countries. He argues that traditional models
that analysed the volatility Emerging markets were static models assuming risk
exposure to be constant over time.
He suggests that Emerging markets are characterised by “Shifting Industrial
Structures”, which suggests changes in risk sensitivities over time.
14. Page 14
Stevenson (2001) confirms the drawback of the traditional Mean-Variance models of
analysing Emerging markets with the underlying assumption of Normal Distribution
of returns.
In this respect, he refers to the study by Bekaert, Erb, Harvey and Viskanta (1998)
which shows that Emerging equity markets display significant skewness and kurtosis
in their returns.
He also refers to the studies by Bekaert and Harvey (1995 and 1997), which show that
the degree of skewness and kurtosis for the distribution of Emerging markets’ returns
alter over time.
Table (2.1) shows summary statistical data for 23 Developed and 15 Emerging
Markets over the period 1988-1997 on a monthly basis.
Table 2.1. Summary Statistics for Emerging and Developed Markets
15. Page 15
Table 2.1. Continued
Source: Stevenson, S. “Emerging Markets, Downside Risk and The Asset Allocation Decision”
The data is based on IFC indices for the Emerging markets and MSCI indices for the
Developed markets.
Table 2.1 shows that, with respect to Mean-Variance measures, Emerging markets
display more variations than Developed markets. This can be seen from the
comparison between the Average Monthly Returns for Developed markets, that vary
between –0.233% for Japan and 1.5037% for Netherlands, and the Returns for
Emerging markets, that vary between –0.7979% for Korea and 2.4731% for
Argentina.
16. Page 16
Variance figures also show greater variation with Developed markets varying between
11.8745 for USA and 59.9113 for Hong Kong and developing markets varying
between 21.3601 for Jordan and 449.0278 for Argentina.
More interestingly, when considering the degree of skewness and kurtosis, most
Emerging markets’ returns display significant results indicating non-normality in the
distribution of returns.
For example, Nigeria shows significant values of kurtosis and skewness of 31.931 and
–3.4479 respectively, compared to 0.4818 and –0.2368 for USA.
The Jarque-Bera (JB) statistics show similar results confirming the departure of Risk-
Return distribution of Emerging Markets from unconditional normality.
Therefore, Stevenson (2001) suggests that this should be considered when designing
the portfolio for an international investor.
Masters (2002) addresses another problem related to investment in Emerging
Markets, that is, the high costs associated with trading.
He classifies the costs into three categories: Management fees, Operating costs –
such as custody, legal and accounting costs – and Transaction-related costs, including
bid-ask spreads and brokerage commissions.
He also estimates the total investment cost to range between 2% and 5% of
investment value per annum with transaction-related costs being the highest
proportion. These can reach as high as 4% per annum.
17. Page 17
To overcome this problem, he suggests a number of strategies to reduce the cost of
each category.
To reduce transaction-related costs, he suggests reducing turnover, using non-local
instruments – such as ADRs - and calculating the after-cost returns when considering
alternative investment schemes in different Emerging markets.
To reduce operating costs, he draws attention to the scale effect of invested funds and
its effect on reducing the cost per dollar invested; as most operating costs are fixed in
nature.
Finally, to reduce management fees, he suggests that active fund management
techniques might be fruitful in emerging markets to generate more superior returns
that cover the high costs of management in these markets.
Saunders and Walter (2002) provide another update about emerging markets by
asserting that the correlations of returns between emerging markets and developed
ones have already increased over the past decade with many traditional barriers to
emerging markets being removed with the overwhelming trend of economic reform
among developing countries. (Table 2.2)
18. Page 18
Table 2.2. Correlations in Returns between Emerging and Developed Markets
Source: Saunders and Walter, “Are Emerging Market Equities a Separate Asset Class”, 2002
They conclude that the traditional consideration of emerging markets’ stocks as being
a separate asset class and, therefore, allocation of funds among countries’ indices will
no longer be sufficient to generate diversification benefits.
Instead, they confirm Master’s suggestion (2002) that the role of active fund
management in exploring market inefficiencies and properly selecting securities and
sectors within these markets will be highly crucial in the future if superior returns are
to be achieved.
The above review of literature about investment in Emerging Markets shows that
Emerging markets tend to exhibit attractive characteristics for international investors
19. Page 19
in terms of portfolio diversification due to the high returns and the low correlation
with mature markets. However, barriers to entry and the high volatility of Emerging
markets are major issues that must be taken into account in the investment decision.
Another important aspect is the recent tendency of Emerging markets to be more
integrated with World markets and, thereby, the diminishing benefit of diversification
to the international investors.
2.2. Market Efficiency
Early formal research about Market Efficiency dates back to the 1950s. Ever since,
the concept of Market Efficiency gained a lot of interest and popularity that the
literature now is so vast and impossible to include in a single review as correctly
indicated by Fama (1991, pp. 1575):
“The literature is now so large that a full review is impossible”.
Therefore, the main work about Market Efficiency, especially that of particular
interest to the purpose of this research, is included.
Many researches consider the work of Maurice Kendall to be the forerunner of the
studies about Market Efficiency.
In his research, Kendall (1953) examined the behaviour of weekly changes in 19
indices of British industrial share prices and in spot prices for cotton (New York) and
in Wheat (Chicago). His conclusions after extensive analysis of serial correlations is
that the stock prices follow a “Random Walk”, that is, stock returns tend to be
independent of past returns. (Fama, 1970)
The first impression of Kendall’s conclusion is that markets are irrational and tend to
act with no sense of direction.
20. Page 20
Later research clarified that Kendall’s conclusion, in fact, reflects the rational nature
of the market.
Fama (1970) defines an Efficient Market as one where information is “Fully
Reflected” in stock prices. That is, investors use the available information about the
stock to determine its fair value. Thus, any information available, or predictable,
about the stock performance would have already been included in the stock price.
Stock price changes will only result form the arrival of new information in the form of
surprises to the market. As new information arrives randomly, so the price changes
will occur randomly.
So, to have an efficient market, the stock prices must “Fully Reflect” the information
set available Φ, which is the basis for classifying the markets.
In this respect, Fama (1970) identifies three types of markets based on three different
sets of information:
• Weak-form efficient, where the prices reflect all available information
about past prices;
• Semi-strong-form efficient, where the prices reflect all publicly
available information, including earnings, companies’ performance,
etc.;
• Strong-form efficient, where the prices reflect all information, public
and private, available to investors.
In addition, Fama (1970) departs from the earlier assumption that securities’ prices
follow a random walk and suggests that they tend to follow a “Submartingale”.
21. Page 21
That is, instead of the restrictive assumption that securities prices, and returns, are
serially independent and identically distributed, he assumes that prices follow a
“Random Walk with a Drift” so that, on the long run, securities returns tend to move
upward; indicating a positive long-term return.
Consequently, Fama (1970) argues that if stock prices follow the above mentioned
pattern, a Submartingale, then no trading rule based on the information set Φ can
outperform a “Buy-and-Hold” strategy.
Subsequent research found relatively supporting evidence to Fama’s hypothesis.
For example, Conrad and Kaul (1988) examined the weekly returns of NYSE stocks
and found relatively small positive serial correlation over short horizons.
This type of research provided support to proponents of Efficient Market Hypothesis.
However, the hypothesis was not free from criticism.
Poterba and Sumers (1988) and Fama and French (1988) found that over longer
horizons, stock prices’ returns show negative long-term serial correlations suggesting
that stock prices might overreact to relevant news in what’s came to be known as the
“Fads Hypothesis” (Bodie, Kane and Marcus, 2001)
Also, Leroy (1989) challenged Fama’s argument (1970) that when prices follow a
submartingale, no strategy can outperform a “Buy-and-Hold” strategy.
He mentioned two reasons to support his argument. First, that Fama did not provide
any supporting evidence for his claim and that, it is easy to provide examples of
markets in which the prices follow a submartingale and, yet, there exist trading rules
that outperform a “Buy-and-Hold” strategy.
22. Page 22
Second, that the Capital Asset Pricing Model (CAPM) implies that, in equilibrium,
asset returns will not necessarily follow a submartingale. That is, a stock’s returns
might negatively co-varies with the market strong enough that it would be included in
a risk averse investor’s portfolio simply to limit the degree of risk exposure.
LeRoy (1989) also pinpointed another drawback of the Martingale Model that Fama
(1970) assumed securities prices to follow. That is, the Martingale model assumes
“Risk Neutrality” and that investors will rush to buy/sell mispriced securities without
consideration to the level of risk exposure this might put them in.
LeRoy (1989) argues that this contradicts with the general notion that investors are,
generally, risk averse and that the level of risk exposure is an important aspect in their
portfolio formation.
In comment on these arguments, Fama (1991) explained that a central assumption in
the volatility tests of his earlier work was that expected returns were constant and that
the variation in stock prices were caused, entirely, by shocks in expected dividends.
He acknowledged the usefulness of volatility tests to show that expected returns vary
through time; however, he argued that these tests, in themselves, do not help in testing
whether the variations in expected returns are rational.
He also mentioned another problem associated with these findings, that most of the
research faced a “Joint Hypothesis” problem where tests were joint tests of efficiency
and the validity of the model used.
Fama (1998) added three reasons to why the detected anomalies that indicate
overreaction, or underreaction, over long-term do not invalidate the Efficient Market
23. Page 23
hypothesis: first, that the literature does not provide a random sample of events;
second, that some apparent anomalies may be generated by rational asset pricing due
to changes in volatility; and third, that most anomalies tend to disappear when
reasonable alternative approaches are used to measure them.
Another recent opposing study attempted to provide new insights into the debate that
markets might not be efficient at all times.
Lewellen and Shanken (2002), argue that the true data generating process might
enable the econometrician to uncover certain patterns in prices and returns that might
either be not perceived, or not exploited by investors even when investors fully utilise
all available information.
This, they argue, is due to “Parameter Uncertainty”, where investors assume that
prices of securities follow a martingale.
This assumption by investors implies that dividend distribution, which they consider
as the crucial cause for price changes, is random with a random mean.
They argue, however, that empirical studies show that prices tend to converge, over
time, to their true fundamental values. This implies that dividend distribution is not
completely random and that, in fact, has a constant mean.
They conclude that, as investors benefit from the learning process when uncertainties
are eliminated, they tend to act in such a way that drives prices to correct (in a mean-
reversion process).
Something, they comment, which data generating process can predict before hands.
24. Page 24
The above review shows that debate about market efficiency is likely to continue with
proponents asserting that markets, on the average, are informationally efficient, while
opponents continue to provide new evidence about market inefficiency and the
possibility of locating opportunities to achieve abnormal returns.
In the mean time, the Efficient Market hypothesis remains a significant area of
interest and its significance increases when Emerging Markets are considered in the
search for exploitable opportunities within these markets.
Mecagni and Sourial (1999) examined the Market Efficiency within the Egyptian
market. Analysis of Egyptian stock returns were conducted using Four daily aggregate
indices which are widely used within the Egyptian market, namely, the Capital
Market Authority Index (CMAI), the Egyptian Financial Group Index (EFGI), the
HERMES Financial Index (HFI) and the Prime Initial Public Offerings Index
(PIPO). A detailed description of the various indices is given in chapter 3.
The test sample consisted of 828 daily observations on stock returns form 1st
September 1994 until end-December 1997 and the analysis were conducted using a
Generalised Auto-Regressive Conditional Heteroscedasticity model (GARCH).
Table 2.3 below shows the main results of the study.
Table 2.3. Unconditional Distribution Statistics for the Egyptian Stock Exchange Daily Stock
Returns
25. Page 25
Source: Mecagni and Sourial, “The Egyptian Stock Market: Efficiency Tests and Volatility Effects”, 1999
From the table, it can be seen that Mean Returns for privatised companies (PIPO) is
double that for all stocks (CMAI) and highly liquid stocks (HFI) and significantly
higher than that for large capitalisation stocks (EFGI).
Also, Variability (as represented by Standard Deviation) is approximately the same
for (EFGI), (HFI) and (PIPO) but significantly less for (CMAI) reflecting infrequent
trading of many listed stocks.
In addition, returns exhibit positive skewness and excess kurtosis for all indices. An
observation that confirms the conclusions of Bekaert et al. (1995, 1997 and 1998) and
of Stevenson (2001) about the distribution of returns in Emerging Markets.
Mecagni and Sourial (1999), conclude that returns display a degree of time
dependence and volatility clustering. This suggests serial correlation of returns, which
26. Page 26
can be used to achieve a degree of predictability based on past returns and, therefore,
implies a departure from the Efficient Market Hypothesis.
In the following chapters, the attempt will be made to provide an update on the market
efficiency of the Egyptian Stock market in the light of the recent improvements and
reform activities.
27. Page 27
Chapter 3 General Preview
3.1. Egyptian Stock Market
Formal Stock market activity in Egypt dates back to 1888 when the Alexandria Stock
Exchange was inaugurated. The Cairo Stock Exchange was established in 1903.
Trading was very active during the 1940s, with the Egyptian Exchange ranking Fifth
most active in the world during that period.
However, due to the Socialist policies adopted by the government, which led to a
major nationalisation program that started in 1959, a drastic reduction in activity
occurred from 1961 till 1991. The two exchanges remained operating during that
period but trading on the floor was effectively dormant.
In 1990/1991, the government started its major economic reform program towards
free market mechanism and privatisation. One of the major dimensions of this
program was the revival of the Capital market through the enactment of the Capital
Market Law No. 95/1992. The law provided great momentum to the market and the
market capitalisation increased dramatically as the reform and privatisation
progressed.
Table (3.1) provides main market indicators for the Egyptian Stock Market for the
period 1991 – June 2001.
28. Page 28
Table 3.1. Main Market Indicators for the period 1991 – June 2001
Source: Cairo and Alexandria Stock Exchanges Fact Book, 2001
From the table, it can be seen that the market capitalisation increased form L.E.8.8
billion in 1991 to L.E. 119.7 billion in 2000 and was slightly reduced to L.E.110.3
billion by the end of June 2001. Also, the number of listed companies increased from
627 in 1991 to 1070 by the end of June 2001.
Volume and value of traded securities also increased dramatically as can be seen from
Graph (3.1) and (3.2), which correspond to lines 3 and 6 of Table (3.1) respectively.
29. Page 29
Graph 3.1. Total Volume of Traded Securities Graph 3.2. Total Value Traded of Securities
(Million), Jan. 1991 – Jun. 2001 (Million), Jan. 1991 – June 2001
Source: Cairo and Alexandria Stock Exchanges Fact Book, 2001
The Egyptian Stock Market is well regulated, however, there’s still limited depth.
While there are 1070 companies listed, trading is concentrated in less than 100
companies with the majority of trading volume and value in about 30 companies.
Table (3.2) below shows that, as at 30 June 2001, 82.26% of market liquidity was
concentrated in 30 stocks.
The table indicates that despite the increased market capitalisation of the Egyptian
Stock Market, trades remain concentrated in a few companies that exhibit real strong
fundamentals.
30. Page 30
Table 3.2. Liquidity of the 30 Most Heavily Traded Stocks in Terms of Value Traded
(Jan. 2001 – 30 June 2001)
Source: Cairo and Alexandria Stock Exchanges Statistical Highlights, 2001
3.1.1. Regulatory Framework
The Egyptian stock Market is well regulated, currently having a number of legislation
that govern the establishment and operation of companies within the market.
The laws that govern the Egyptian Stock Market operations are:
31. Page 31
The Capital Market Law (Law 95/1992)
Replacing Law 161/1957, the Capital Market Law came into effect in 1992. This law
provided the main regulatory framework for the activities of the stock market by
recognising primary and secondary markets, the organisation of the market
participants, listed companies and stockbrokers, the provision of a modern mechanism
for trading and investment through the market and the exemptions and incentives to
boost the market and provide its depth.
One of the main advantages of the law was the recognition of the central role of the
Capital Market Authority (CMA) and the powers it was given by the law to organise
and control the market. Following the enactment of the law, the Capital Market
authority played and important role in modernising the market through authorising
listed companies and brokerage firms and the monitoring function over the activities
of the exchanges towards more transparency and fair dealings.
The Central Depository Law (Law 93/2000)
This laws aims to provide the legal framework for the Central Depository in Egypt.
The law identifies shareholders’ rights and their legal ownership, which are stated to
pass from the seller to the buyer of securities when the trade is actually cleared and
settled at the stock exchange on settlement date.
The law also recognises foreign ownership rights, which are the same as those of
Egyptian shareholders, and provides mechanism for membership and operation of
organisations carrying out bookkeeping activities either for themselves or on behalf of
their clients.
32. Page 32
The law also introduced the legal recognition of the concept of “Nominee Trading”
and the Depository’s obligation to establish and control a “Guarantee Fund” which
ensures the settlement of trades on time to achieve smooth market operation.
The Companies Law (Law 159/1981)
This law provides the framework for the establishment and operation of companies
within the Arab Republic of Egypt.
The law covers the main establishment procedures, the management and control
responsibilities, the extent of liability of owners, the required accounting and financial
control procedures and all other aspects that a company may encounter in the course
of its business.
The Privatisation Law (Law 203/1991)
This law is the basic legislation for the development of the privatisation program and
encouragement of economic reform.
The main aim of the law was to transfer the Government-owned authorities into self-
run Holding Companies under which Public Sector companies can be given greater
flexibility to operate its business activities away from the central government control.
(As per explanatory memorandum attached to the law by The Prime Minister)
The law is considered a transitory phase to provide the public sector firms with the
mechanism to restructure so as to become attractive candidates for privatisation.
This law regulates companies in which the government possesses 51% or more of its
shares. When the government’s share of ownership in a company drops to less than
51%, the regulation of the company passes from law 203 to law 159.
33. Page 33
The Investment Law (Law 8/1997)
This law was enacted to encourage direct and indirect investment in certain industries
and sectors of the economy.
The law provides tax exemptions, guarantees against asset expropriation, attractive
custom tariffs and freedom from price controls.
In addition to the above legislation, the Cairo and Alexandria Stock Exchanges
(CASE), in liaison with the Capital Market Authority set a number of Listing Rules
for companies wishing to be listed and traded on the exchange. Appendix A details
the existing Listing Rules as well as the proposed new Listing Rules which are
expected to come into effect later in 2002 with the aim of increasing transparency,
efficiency of information dissemination and corporate governance of the companies
listed.
3.1.2. The Exchange
Egypt’s Stock Exchange has two locations: the main location is in Cairo and the other
one is in Alexandria. Both exchanges are managed by the same Chairman and Board
of Directors and are commonly referred to as the Cairo and Alexandria Stock
Exchanges. (Cairo and Alexandria Stock Exchanges Fact Book, 2001)
The Chairman of the Exchange is appointed by the government. The Board of
Directors includes directors elected from market participants as well as nominated
representatives of the Capital Market Authority (CMA), the Central Bank of Egypt
(CBE) and the Banking sector. In addition, there are three non-voting members.
34. Page 34
The trading system in the exchange evolved from an open outcry system prior to 1992
to the existing fully automated, order-driven system. The existing system incorporates
trading, clearing and settlement of trades with an automated link to the Central
Depository. The system also provides automatic mechanism for market surveillance
for better market performance. (CASEFB, 2001)
The exchange is regulated by the Capital Market Law (Law 95/1992) and sets, in
conjunction with the Capital Market Authority (CMA), the listing rules for
companies.
Currently, companies can be listed on either the Official Schedule or Unofficial
Schedules (1) and (2).
Although the listing requirements for the Official Schedule and Unofficial Schedule
(1) are similar, the requirements of the Official Schedule are more stringent.
To be listed on the Official Schedule, companies must have at least 150 shareholders
and offer, at least, 30% of their shares to the public or be one of the companies
regulated under Law 203.
Companies not qualifying for the requirements of the Official Schedule can be listed
on the Unofficial Schedule (1).
Unofficial Schedule (2) was introduced in February 1998 to cater for new companies,
which cannot, at their initial stage, satisfy the more rigorous requirements of the
Official Schedule and Unofficial Schedule (1).
By the end of June 2001, 141 companies were listed on the Official Schedule and 929
companies on Unofficial Schedules, of which 229 companies were listed on
Unofficial Schedule (2). (CASEFB, 2001)
35. Page 35
3.1.3. Indices
There are a number of indices that serve as Benchmarks for the Egyptian market.
For local investors, the following indices are usually followed:
The Capital Market Authority Index (CMAI)
Started on 2nd
January 1992, the index includes all listed stocks weighted in relation to
their market capitalisation. It can be viewed as an All-Share index that covers the
broadest base of stocks. (Mecagni and Sourial, 1999)
Cairo and Alexandria Stock Exchanges 50 Index (CASE50)
Started on 2nd
January 2000, the index tracks the performance of the most active 50
stocks. Currently there are two versions of the index, the (CASE50 Price Index),
which measures the return on investment from the change in value of the stocks. The
second version is the (CASE50 Total Return Index), which measures the return on
investment form both income from dividend and capital gains.
Both indices are market capitalisation weighted and the constituents are reviewed
semi-annually. (CASEFB, 2001)
In addition, a number of companies are calculating their own indices and those
include:
HERMES Financial Index, (HFI)
Started on 2nd
January 1993, the index tracks the performance of a number of active
companies in the market with a minimum of three months active trading history. The
index is market capitalisation weighted and revised quarterly. (Mecagni and Sourial,
1999)
36. Page 36
As at June 2001, the index included 48 companies. (CASEFB, 2001)
Egyptian Financial Group Index (EFGI)
Started on 2nd
January 1993, the index tracks the performance of a subset of the
HERMES Financial (HFI). The index tracks the performance of listed Large
Capitalisation stocks with minimum L.E.300 million in market capitalisation and the
constituents are revised quarterly. (Mecagni and Sourial, 1999)
As at June 2001, the index included 23 companies. (CASEFB, 2001)
Other companies also calculate their own indices including, Prime that calculates
(Prime Initial Public Offerings – PIPO), (Prime Asset Management Index – PAMI)
and (Prime General Index – PGI).
The first is a price index that tracks the performance of companies, which were
offered to the public through Initial Public Offerings (IPOs). As at December 2001,
the number of companies included was 67 companies. (Prime Research, 2001)
The second index tracks the performance of Large Capitalisation companies. As at
December 2001, the number of companies included was 18 companies. (Prime
Quarterly Review, Dec. 2001)
The last one is a general index, which tracks the performance of a wide range of
active companies. As at March 2002, the number of stocks included was 32. (Prime
News Flash, March 2002)
Beside Local indices, and due to the foreign interest in Egyptian equities, Egypt was
included in the International Finance Corporation’s Global and Investable indices
37. Page 37
(IFCG and IFCI) in 1996. Egypt was added to the Morgan Stanley index on a stand-
alone basis in 1997.
In May 2001, Egypt was included in the Morgan Staley Emerging Markets Free
(EMF), (EMEA, excluding South Africa) and All Country World Index (ACWIF) at
weights of 0.28%, 2.12% and 0.14% respectively. (CASEFB, 2001)
3.1.4. Key Economic Sectors
Egypt’s success in implementing sound economic policies, the acceleration of the
privatisation process and liberalization of trade are reflected in the healthy economic
indicators that Egypt enjoys.
Table (3.3) below depicts the main economic indicators for Egypt for the period 1997
till 2000.
Table 3.3. Main Economic Indicators 1997 - 2000
Source: HSBC Investment Bank – Egypt, “Treasury and Capital Markets: A Guide to Egypt”, 2001
38. Page 38
Table (3.3) shows GDP growth rate of 5.1% in 1999/2000, down from 6.1% in
1998/1999 due to the economic slowdown, which was a reflection of the global
economic conditions.
Egypt’s inflation rate has also declined from 3.8% in 1998/1999 to 2.8% in 1999/2000
with an average rate below 4% for the entire period from 1997 – 2000.
Foreign Reserves have declined from US$ 20.3 billion in 1997/1998 to US$ 14.7
billion in 1999/2000 due to the government’s managed float, foreign exchange policy.
However, the level of reserves remains healthy covering approximately 9 months of
imports.
Exports increased by 42% in 1999/2000 while imports have shown a steady growth at
approximately 5%.
Perhaps the major challenge for the Egyptian government is the level of
unemployment, which is worsening with the persistent growth in population. This has
been indicated by the government as one of the major priorities in several statements
by both the President and the Prime Minister.
In the following lines a brief description of the key economic sectors that contribute to
economic and business development are described.
Banking
The banking sector is one of the well-established sectors in the economy with the first
bank in Egypt dating back to the 1920s.
39. Page 39
The banking sector in Egypt consists of the Central Bank of Egypt (CBE), which is
the governing body, 24 Commercial and Joint-Venture banks, 11 Investment banks, 3
Specialised banks and 15 branches of Foreign banks. (HSBC, 2001)
The Central Bank of Egypt was established in 1960 and its main responsibilities
include formulating the monetary, credit and banking policy, the issuance of bank
notes, management of the state’s reserves, control of banks, and the management of
public debt on behalf of the government.
Commercial banks possess a dominant role in the financial sector in Egypt with 4
Public Sector and 5 Private sector banks dominating the banking activities.
Public sector banks control approximately 53% of banking total assets and 60% of
total deposits. However, Private sector banks outperform Public sector banks in terms
of profitability. (CASEFB, 2001)
There are currently 11 Investment banks in Egypt providing a range of services
including Corporate Finance, Advisory, Securities, Debt and Equity Capital
Management, Project and Export Finance and Asset Management Services. (HSBC,
2001)
There are 3 Specialised banks in Egypt. The Egyptian Arab Land Bank extends loans
to the housing, building and land sector. The Industrial Development bank finances
the industries and the Principal Bank for Development and Agricultural Credit
finances the agricultural sector in Egypt. (HSBC, 2001)
40. Page 40
Following the 1996 Banking and Credit law, a lot of deregulation has occurred in the
banking sector with fixed commission and Reserve requirement on time deposits
exceeding 3 years (15%) effectively abolished.
The law also allowed 100% foreign ownership of local banks but Central Bank of
Egypt’s approval is required before any acquisition exceeding 10% of capital.
(CASEFB, 2001)
Tourism
Tourism receipts account for approximately 5% of GDP and is one of the major
contributors to the government’s revenue.
Two of the major problems that affect the industry are the Instability of flows and the
poor infrastructure and marketing.
Realising these problems, both the government and private sector have taken several
steps to boost the sector by developing the facilities and undertaking proper marketing
campaigns. Most of the recent developments in the facilities took place in Sinai and
the Red Sea coast.
Year 2000 witnessed an increase in both the number of tourists, with 5.5 million
arrivals, and revenues, which increased by 33% to US$ 4.7 billion. (CASEFB, 2001)
Cement
Cement is one of the most active and profitable sectors. This sector has witnessed a
boom during the 1990s. During the period 1993-1999, the sector grew at an average
10.9%. This was in direct relation to an average growth in GDP of 5% per annum and
an average growth in construction industry of 2.5% per annum. (HC, 2001)
41. Page 41
With strong local demand exceeding supply, producers were able to operate at very
high profit margins. As a result, a wave of foreign interest in the Egyptian cement
sector spurred in the form of major acquisitions in Egyptian companies.
Table (3.4) below shows the current market share of three of the largest cement
producers in Egypt as of 2001.
Table 3.4. Market Share of the Three Largest Cement Producers in Egypt, (2001)
Source: HC Brokerage, “Egypt: Equity Research”, 2001
As a result, capacity additions rose by 10.2% in 2000 and by 28.7% in 2001. This
increase in capacity, coupled with the economic slowdown and stagnation in
construction industry in 2000/2001, resulted in supply exceeding demand for the first
time in 2001/2002. (HC, 2001)
As the Egyptian economic slowdown was a reflection of a global recession, exports
did not benefit from the excess supply and producers had to reduce the production
levels and sell at fairly lower prices.
However, it is expected that once the global recession comes to an end, and with the
expected new tranches of Public Sector companies offered for privatisation, the sector
will regain its momentum and offer attractive opportunities for investors.
42. Page 42
Telecommunications
The telecommunications sector in Egypt is one of the promising sectors offering a
great potential for development and growth.
The sector is currently divided into fixed Land Lines and Cellular markets. Both
markets are regulated by the Telecommunications Regulator Authority (TRA), which
oversees the quality and regulates the pricing of services provided.
Currently, the fixed Land Line market serves 6 million subscribers and the Cellular
market consists of two Mobile services companies that serve over 2.5 million
subscribers. It is expected that by 2003, when the exclusivity period for the existing
two companies ends, other companies will be allowed into the market and this should
increase competition and enhance the quality even further. (CASEFB, 2001)
Finally, with less than 8% penetration for fixed Land Lines and 2% penetration of
Mobile Phone services, the Egyptian market is still under serviced offering great
opportunities for investment. (CASEFB, 2001)
Energy
This sector is comprised of Petroleum, Natural Gas and Electricity. It is one of the
most important sectors in the Egyptian Economy and contributes approximately 6%
of GDP.
Petroleum is one of the major sources of foreign currency and represents
approximately 40% of export revenues. Annual production is around 30 million tons
43. Page 43
while consumption is around 20 million tons with the surplus being exported.
Approximately 79% of Egypt’s oil comes from the Gulf of Suez and Sinai with new
excavations indicating reserves in both the Eastern and Western deserts.
Natural Gas is increasingly replacing oil products in Egypt with reserves of
approximately 50 billion cubic feet of high quality gas.
With these huge reserves, the government aims to encourage switching into gas
products and to export liquefied gas to provide another source of foreign currency.
Electricity sector contributes approximately 2% of Egypt’s GDP. Sources of
electricity include 20% from hydroelectric generation, 53% from gas-fired steam
plants and 26% from cycle plants.
Currently, domestic consumption is around 57 billion KWH, with demand increasing
about 7% per annum.
Electricity is currently under state control, however, it is expected that the government
will start offering a tranche of two of the major companies, namely Greater Cairo and
Canal Electricity companies, for privatisation. (CASEFB, 2001)
3.1.5. Market Participants
As at June 2001, there were 146 brokerage firms operating in Cairo and Alexandria.
The top 30 brokers represented more than 70% of the traded value in 2001 with the
remaining brokerages representing the remaining 30%. (CASEFB, 2001)
Brokerage firms may be 100% foreign owned, but the Chief Dealer must be a locally
experienced market professional. (HSBC, 2001)
44. Page 44
Under the Capital Market Law, the Capital Market Authority (CMA) is the licensing
agency for both listed companies and brokerage firms.
Previously, the (CMA) requirements was that a brokerage firm must have a minimum
Authorised Capital of L.E. 1.5 million. However, the more recently introduced Capital
Adequacy requirements mandate that new brokerage firms must have a minimum
Authorised Capital of L.E. 5 million. New brokerage firms are also required to have a
minimum of 10 operating branches spread all over Egypt. (HSBC, 2001)
These more stringent requirements were introduced in an attempt to rationalise the
number of brokerage firms offering their services in the market and, thereby,
improving the quality of services rendered.
As at June 2001, 22 local funds (19 Open-end and 3 Closed-end) and 10 Offshore
funds were operating in the market.
In addition, there were 31 Portfolio Management firms, 29 Underwriters, 11 Venture
Capital firms and 6 rating companies operating in the Egyptian market. (CASEFB,
2001)
3.1.6. Instruments
Equities are the main instrument in the market, which provide the bulk of trading.
Since 1998, the issues offered in the secondary market have increased in terms of
diversity and volume. One main reason for the development of the market was the
government commitment towards the privatisation program by offering new firms to
the public.
45. Page 45
Fixed income market has witnessed rapid expansion with the government introducing
several issues of Housing and Treasury bonds with maturities ranging from 7-10 years
ever since 1998. Private sector companies have also taken the authorisation granted to
them by the Capital Market Law and started issuing Corporate Bonds to diversify
their financing to other sources than banking finance.
However, the secondary market in bonds is still largely inactive compared to the
equities market. This can be seen from the market capitalisation for both Government
and Corporate bonds of L.E. 17.9 billion in June 2001 as compared to L.E. 110.3
billion for equities. (CASEFB, 2001)
Depository Receipts provide another type of instruments for the market. As of June
2001, Nine Egyptian companies had their shares traded in the form of Global
Depository Receipts on the London Stock Exchange. Of these nine companies, Three
are also listed on Frankfurt Stock Exchange and One is listed on the Luxembourg
Stock Exchange.
Several Egyptian companies are currently studying the possibility of issuing
American Depository Receipts in the American market. (CASEFB, 2001)
From the above review, it can be seen that the Egyptian market has undertaken
several measures both in terms of regulation and performance to ensure lower barriers
and better quality for local and international investors.
However, concentration and lack of depth, in terms of the types of instruments
available, are still material issues that affect the market performance and should be
handled effectively if the market is to improve its efficiency.
46. Page 46
3.2. Market Performance
Market analysis for the period 1996 till 1st
quarter 2000 is based on the analysis included in “EFG-
Hermes: Country Report, May 2000”.
Additional analysis for the period 2nd
quarter 2000 till 2001 is based on the analysis included in “Cairo
and Alexandria Stock Exchanges Fact Book, 2001”
Performance analysis is based on the performance of the Hermes Financial Index for the period 1996-
2001.
Despite the fact that the Capital Market Law (Law 95/1992) gave the regulatory
power to reform the Stock Market in Egypt, it wasn’t until 1996 when “Nasr City for
Housing and Development Company” offered the first majority privatisation stake in
accordance with the aims and objectives of the Privatisation Law (Law 203/1991).
Ever since, the market dynamics changed and the market started a sharp climb with
the Hermes Financial Index ending the year 1996 with a gain of 43% most of it within
the second half of the year (Graph 3.3).
Graph 3.3. Overall Market Performance, (1996 – 1998)
Source: EFG-Hermes, “Egypt: Country Report”, 2000
This momentum continued in the early months of 1997 when the market reached its
all-time peak on 27 February 1997. However, the sharp rise was based on weak
47. Page 47
market fundamentals and a downward trend took place for the rest of 1997 and most
of 1998.
In the mean time, and during 1998, the market started shifting from traditional “Value
Stocks” to new-economy “Growth Stocks” when the private sector started offering
major issues in the market.
The market ended the year 1998 down by approximately 26% and despite the 27%
loss on public sector equities, private sector equities ended the year with a 36% gain
(Graph 3.4)
Graph 3.4. Private versus Public Sector Share Performance, 1998
Source: EFG-Hermes, “Egypt: Country Report”, 2000
In early 1999, the market started rising once again. This was mainly attributed to the
initial public offering of “Mobinil”, the first in telecommunication sector, which
marked the market shift towards more sophistication in trading decisions with
Mobinil’s share price ending 1999 with 660% increase.
48. Page 48
In the mean time, a liquidity squeeze became apparent amid concerns about the
government’s management of the economy and its commitment to the privatisation
programme. This drove the market down for the most of 1999. (Graph 3.5)
Graph 3.5. Market Performance, (1998-1999)
Source: EFG-Hermes, “Egypt: Country Report”, 2000
In October 1999, a cabinet change was declared and the market immediately reflected
its anticipation about the declared change in the form of a market rise that took place
in the last quarter of 1999 and continued in the 1st
quarter of 2000.
During the 1st
quarter of 2000, a wave of consolidations took place both in the Cement
and Banking sectors with offers from local and foreign investors driving share prices
up, particularly in the Cement sector.
However, with liquidity tied up in Cement shares, other stocks started suffering,
which led, eventually, to the market drop by mid. February 2000. (Graph 3.6)
49. Page 49
Graph 3.6. Market Performance, (2000 – 2001)
0
2000
4000
6000
8000
10000
12000
14000
16000
02/01/2000
02/02/2000
02/03/2000
02/04/2000
02/05/2000
02/06/2000
02/07/2000
02/08/2000
02/09/2000
02/10/2000
02/11/2000
02/12/2000
02/01/2001
02/02/2001
02/03/2001
02/04/2001
02/05/2001
02/06/2001
02/07/2001
02/08/2001
02/09/2001
02/10/2001
02/11/2001
02/12/2001
HFI
Source: REUTERS / EFG-Hermes
The general downturn continued during the rest of 2000 and throughout 2001 with the
market being down by 59.6% from early 2000. This was mainly attributed to the
global downturn, the slow pace of privatisation and the political circumstances in the
Middle East Region.
In this respect, Egypt was no exception of other emerging markets that lost substantial
amount of their value during the same period mainly due to the global economic
slowdown.
50. Page 50
Chapter 4 Market Efficiency
4.1. Methodology
4.1.1. Event studies
The approach adopted in testing for market efficiency within the Egyptian Stock
market is “Event Studies” as suggested by Fama, Fisher, Jensen and Roll (1969).
In this approach, stock returns are examined around the date new information about
the performance (or prospects) of a company is announced. The speed of response of
the stock returns to the new publicly available information indicates the degree of
efficiency.
Thus, if securities returns adjust immediately to new information, this will be an
indication of an overall “Semi-strong, efficient” market.
If, on the contrary, securities returns respond slowly, thereby allowing the uninformed
investor to achieve abnormal returns by simply observing the price behaviour without
any additional fundamental analysis, this will be an indication of an overall “Semi-
strong, inefficient” market.
The tests were conducted using an Ordinary Least Squares regression model (OLS) to
identify the stock’s Expected Normal Returns and, hence, any deviation of Actual
Returns from Expected returns in the form of Unexpected Abnormal Returns.
51. Page 51
Mathematically, the returns of a security can be represented by the following formula:
ri = αi + βirM + ei (4.1)
Where, ri is the return on security i, αi is the initial return (the return on security i
when the market return is zero), βi is the sensitivity of the returns of security i to
market returns, rM is the market return (the return on a benchmark index representing
the market portfolio), and ei is the deviation of the actual returns of security i from
expected returns, also known as security i’s abnormal returns
From equation (4.1), the abnormal returns of a security can be found be rewriting the
equation to be:
ei = ri – (αi + βirM) (4.2)
Equation (4.2) will be the basis for calculating Abnormal Returns throughout the
analysis.
In order to avoid problems associated with equilibrium models when measuring
returns (Fama, 1998), the following procedure was adopted:
• using Cumulative Abnormal Returns (CAR) to measure abnormal
returns surrounding the event examined instead of the Buy-and-Hold
Average Returns (BHAR) method;
• returns were measured over short horizons to provide better results
under the assumption of securities returns being normally distributed.
52. Page 52
This helps avoiding the problem of skewness of returns that characterises the stock
returns in Emerging markets (Bekaert et al., 1995, 1997 and 1998) and (Stevenson,
2001).
4.1.2. Beta Calculation
The benchmark, relative to which the sensitivities of securities returns were measured,
is the Herms Financial Index (HFI).
The choice of index was due to its mature nature (inception, 2nd
January 1993) and its
wide scope that includes the highly traded companies, which provides a more reliable
proxy for the market.
The calculation was based on the weekly returns of the index for the period from the
beginning of January 1998 until the end of December 1999.
In the calculation, it was assumed that the value of Beta has been constant for the
period 1st
January 1998 till 31st
December 1999 and that this value was different from
that of prior periods.
Table 4.1 shows the values of Standard Deviation, Skewness and Kutosis for the
index returns for the periods 1996/1997, 1998/1999 and 2000/2001.
56. Page 56
08/08/1999 9532.29 0.980691 -1.95 05/08/2001 5285.55 0.959409 -4.14
15/08/1999 9350.49 0.980928 -1.93 12/08/2001 5535.72 1.047331 4.62
22/08/1999 9441.02 1.009682 0.96 19/08/2001 5619.18 1.015077 1.50
29/08/1999 9353.39 0.990718 -0.93 26/08/2001 5647.62 1.005061 0.50
05/09/1999 9286.50 0.992849 -0.72 02/09/2001 5957.84 1.054929 5.35
12/09/1999 9238.43 0.994824 -0.52 09/09/2001 6427.37 1.078809 7.59
19/09/1999 9365.83 1.013790 1.37 16/09/2001 6263.37 0.974484 -2.58
26/09/1999 9633.55 1.028585 2.82 23/09/2001 6148.17 0.981607 -1.86
03/10/1999 9644.66 1.001153 0.12 30/09/2001 5619.25 0.913971 -9.00
10/10/1999 10084.30 1.045584 4.46 07/10/2001 5446.80 0.969311 -3.12
17/10/1999 10673.40 1.058418 5.68 14/10/2001 5545.29 1.018082 1.79
24/10/1999 10192.30 0.954925 -4.61 21/10/2001 5797.97 1.045567 4.46
31/10/1999 10382.80 1.018691 1.85 28/10/2001 5713.35 0.985405 -1.47
07/11/1999 10475.50 1.008928 0.89 04/11/2001 5548.61 0.971166 -2.93
14/11/1999 10715.10 1.022872 2.26 11/11/2001 5581.92 1.006003 0.60
21/11/1999 10771.40 1.005254 0.52 18/11/2001 5333.98 0.955582 -4.54
28/11/1999 11042.20 1.025141 2.48 25/11/2001 5085.62 0.953438 -4.77
05/12/1999 11522.50 1.043497 4.26 02/12/2001 5196.33 1.021769 2.15
12/12/1999 13386.90 1.161805 15.00 09/12/2001 5164.32 0.993840 -0.62
19/12/1999 12357.80 0.923126 -8.00 16/12/2001 5342.09 1.034423 3.38
26/12/1999 12152.40 0.983379 -1.68 23/12/2001 5311.80 0.994330 -0.57
30/12/2001 5262.41 0.990702 -0.93
Std. Dev. 3.26 2.80 4.56
Skewness 0.80 1.81 0.11
Kurtosis 0.84 8.29 0.79
1. Index values for the period prior to November 1996 were unobtainable during the research conducted. However, including
Those values would have made the validity of the statistical measures for the period questionable as many of the highly-liquid/
highly-traded stocks were listed during late 1996 and started active trading during 1997.
57. Page 57
The table shows that Standard Deviation has decreased from 3.26% for the period
1996/1997 to 2.8% for the period 1998/1999 indicating a mild volatility during the
second period.
Skewness and kurtosis coefficients have increased during the period 1998/1999
indicating an increased shift in returns from normal distribution.
Based on the above, the calculation of Beta for the stocks analysed has been confined
to the period 1998/1999 and the values obtained were used to measure abnormal
returns for securities around announcements related to acquisitions and dividend
distributions during 2000 and 2001.
Finally, in the calculation, continuous compounding of both index and securities
returns was assumed. This can be shown by the following mathematical formulae:
rI = ln (Vt / Vt-1) (4.3)
ri = ln (Pt / Pt-1) (4.4)
Where, rI is the index return, Vt is index value at date t, Vt-1 is index value at date t-1,
ri is the return on security i, Pt is security price at date t, Pt-1 is security price at date
t-1 and ln is the natural logarithm of value calculated
Appendix B shows the detailed Beta calculations for the 12 securities analysed, which
are a subset of the most actively traded stocks and for which dividend and/or
acquisition data were available for the period analysed. (Note that the most actively
traded 30 securities accounted for 82.26% of market liquidity as of June 2001 which
58. Page 58
makes the number of securities analysed a fair representation of the market under the
information constraint).
4.2. Data
For the 12 securities involved, Beta calculations were based on 104 weekly
observations of index values and securities prices starting from 2nd
of January 1998
until 24th
December 1999.
Calculations of Abnormal Returns around dividends and acquisitions announcements
were based on 42 daily observations of index values and securities prices surrounding
the Announcement date for each case.
Index values were obtained from REUTERS while stock prices were obtained from
various sources including REUTERS, DATASTREAM and the Cairo and Alexandria
Stock Exchanges website.
The 12 securities analysed are all “Large Capitalisation-Value” stocks to avoid
anomalies associated with “Small Capitalisation-Growth” stocks, which are
characterised by the lack of accurate information and analysis and by infrequent
trading within the Egyptian market.
Table 4.2 below provides summary statistics of the 12 securities analysed. These
securities represent the major sectors of the market and were used as proxies for the
overall market performance.
59. Page 59
Table 4.2. Summary Statistics of Stocks Analysed
Company Beta Alpha Std. Dev. Of Rdm Std. Error of Std. Error of Correlation Coefficient of Coefficient of
% Error Term % Beta Alpha Coefficient Determination Nondetermination
Banking
Commercial International Bank (CIB) 1.45 -0.06 3.12 0.062 0.174 0.80 0.63 0.37
Egyptian American Bank (EAB) 1.18 -0.40 3.38 0.065 0.181 0.70 0.49 0.51
Misr International Bank (MIBANK) 1.27 -0.36 3.14 0.062 0.174 0.75 0.57 0.43
Cement
Ameryah Cement 1.05 -0.43 3.58 0.067 0.187 0.64 0.41 0.59
Helwan Portland Cement 0.85 -0.56 3.26 0.064 0.178 0.60 0.35 0.65
Suez Cement 1.26 -0.20 2.71 0.058 0.162 0.80 0.63 0.37
Torah Portland Cement 1.07 -0.06 3.77 0.068 0.191 0.63 0.39 0.61
Food and Beverages
Upper Egypt Flour Mills 0.87 -0.75 4.91 0.078 0.218 0.45 0.20 0.80
Housing
Nasr City for Housing and Development 0.75 -1.15 4.44 0.074 0.208 0.43 0.18 0.82
Chemicals
Abu Keir for Fertilisers 0.47 -0.94 3.89 0.070 0.194 0.33 0.11 0.89
Egyptian Financial and Industrial 0.86 -1.26 2.86 0.060 0.167 0.65 0.42 0.58
Paints and Chemical Industries 0.78 -0.71 4.10 0.071 0.200 0.47 0.22 0.78
60. Page 60
The only exception with securities selection was for companies within the
Telecommunication and Media sector, where none of the constituent companies was
included as most of the companies in the sector are relatively newly listed with hardly
any dividend or acquisition data available for the period analysed.
4.3. Findings
Appendix C provides the detailed calculations of Abnormal Returns for the securities
analysed around the announcement dates of the various events tested.
4.3.1. Takeovers
Efficiency tests related to Acquisition events included the acquisition announcements
for two companies in the cement sector during 2001, namely the acquisition of
94.69% of Helwan Portland Cement shares by the Arab Swiss Engineering Company
(ASEC) and 34.65% of Suez Cement shares by Ciments Francais. (Cairo and
Alexandria Stock Exchanges Monthly Bulletin, May 2002)
Tables (4.3) and (4.4) and Graphs (4.1) and (4.2) show the following:
Despite fluctuating around 0.40% per day, which might be considered relatively
insignificant, Average Abnormal Returns have shown positive values for the entire
period of the test.
This persistent positive trend has caused Average Cumulative Abnormal Returns to
increase at a steady rate during the period.
A possible explanation for this behaviour is that there might have been an information
leakage about the intended acquisitions well before the announcement date. This has
caused abnormal returns to be positive days before the announcement date.
62. Page 62
Graph 4.1. Average Abnormal Returns surrounding Takeovers in 2001
Average Abnormal Returns: Takeovers (2001)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
AAR(%)
Graph 4.2. Cumulative Abnormal Returns surrounding Takeovers in 2001
Average Cumulative Abnormal Returns: Takveovers (2001)
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
ACAR(%)
Slow Adjustment
Information Leakage
63. Page 63
The fact that the Egyptian Stock Exchange imposes a price limit on the maximum and
minimum the price of a security can reach in a day (plus or minus 5% of closing price
of the previous day), may have caused the slow adjustment of the securities’ prices to
their new fair values and, therefore, caused the increasing cumulative abnormal
returns after the announcement date.
4.3.2. Dividend Increase
Efficiency tests of dividend increases attempted to measure market reaction to good
news about companies performance. The tests measured returns behaviour around the
announcement date for companies, which announced dividend payments higher than
previous years during 2000 and 2001.
Tables (4.5), (4.6), (4.7) and (4.8) and figure (4.1) show the following:
Average Abnormal Returns tended to rise in the 5 days prior to the Announcement
Date (indicating information leakage), fall during the 1-3 days following the
announcement date (a form of market correction indicating overreaction on the leaked
information, which is then corrected after the exact payment is made known to the
public) and then rise again to fluctuate around certain positive level (0.50% in 2000
and 0.25% in 2001).
Fluctuations tended to be more volatile during 2000, however, in both cases, Average
Abnormal Returns remained positive before and after the announcement date causing
Cumulative Abnormal Returns to increase during the entire test period indicating the
information leakage before the announcement date and the slow adjustment after the
announcement date.
68. Page 68
Figure 4.1. Abnormal Returns surrounding Dividend Increase, (2000-2001)
Average Abnormal Returns: Dividend Increase (2000)
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
AAR(%)
Average Abnormal Returns: Dividend Increase (2001)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
AAR(%)
Average Cumulative Abnormal Returns: Dividend Increase ( 2000)
0.00
5.00
10.00
15.00
20.00
25.00
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement date
ACAR(%)
Information Leakage
Slow Adjustment
Average Cumulative Abnormal Returns: Dividend Increase (2001)
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
ACAR(%)
Information Leakage
Slow Adjustment
69.
70. Page 70
4.3.3. Dividend Decrease
Efficiency tests of dividend decreases attempted to measure market reaction to bad
news about companies performance. The tests measured returns behaviour around the
announcement date for companies, which announced dividend payments lower than
previous years during 2000 and 2001.
Tables (4.9), (4.10), (4.11) and (4.12) and figure (4.2) show the following:
The distribution of Average Abnormal Returns prior to the announcement date tended
to be random, though still showing positive values. Following the announcement date,
Average Abnormal returns dropped (an immediate drop in 2000 while gradual drop
via series of undershooting and corrections in 2001) in the following 5-10 days and
then, fluctuated around certain positive level. (0.64% in 2000 and 0.725% in 2001)
This trend of Average Abnormal Returns to show positive values caused Average
Cumulative Abnormal Returns to show an increasing trend.
One explanation of this trend is that the market immediately responded to the bad
news in the form of a downward shock of Abnormal returns, however, the ability of
companies to pay dividends, though lower than previous years, is regarded as a good
sign and helped maintaining the positive values for Abnormal returns.
Again, the slow readjustment of the securities prices to their new fair values caused
Cumulative Abnormal Returns to increase following the announcement date.
75. Page 75
Figure 4.2. Abnormal Returns surrounding Dividend Decrease, (2000-2001)
Average Abnormal Returns: Dividend Decrease (2000)
0.54
0.56
0.58
0.60
0.62
0.64
0.66
0.68
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
AAR(%)
Average Abnormal Returns: Dividend Decrease (2001)
0.67
0.68
0.69
0.70
0.71
0.72
0.73
0.74
0.75
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
AAR(%)
Average Cumulative Abnormal Returns: Dividend Decrease (2000)
0.00
5.00
10.00
15.00
20.00
25.00
30.00
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
ACAR(%)
Information Leakage
Slow Adjustment
Average Cumulative Abnormal Returns: Dividend Decrease (2001)
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
-20 -15 -10 -5 0 5 10 15 20 25
Days relative to Announcement Date
ACAR(%)
Information Leakage
Slow Adjustment
76. Page 76
4.4. Conclusion
From the above, an overall conclusion can be drawn that the Egyptian stock market
showed a clear departure from the “Semi-strong, efficient” market hypothesis in the
period 2000/2001 with two major characteristics of 1) information leakage prior to the
announcement dates and 2) slow readjustment following the announcement dates.
These two drawbacks make it relatively easy for uninformed investors to achieve
abnormal returns by simply observing the price behaviour of securities without any
additional analytical effort.
