The nexus between bond liquidity, stock liquidity and foreign portfolio investment

Authors

  • Godfrey Marozva
  • Patricia Lindelwa Makoni University of South Africa

DOI:

https://doi.org/10.20525/ijfbs.v10i3.1348

Keywords:

liquidity, illiquidity, bond market liquidity, stock market liquidity, foreign portfolio investment, emerging markets

Abstract

The purpose of this article was to assess the impact of financial market liquidity on international capital flows in emerging markets. Specifically, the research investigates the effect of bond market liquidity and stock market liquidity on foreign portfolio investments using data for five emerging African countries, being Egypt, Kenya, Mauritius, Nigeria and South Africa, for the period 2000 to 2020. The data was sourced from the Bloomberg and World Bank (WDI) databases. Panel data analysis (fixed effects model) was undertaken using three different liquidity measures: the effective spread; Amihud’s (2002) illiquidity measure; and market impact as measured by trading volume. Our findings revealed mixed results. It was found that stock market liquidity attracted foreign portfolio investments. Although bond market liquidity, as measured by the volume of trade, promoted foreign portfolio investment, it was different for the effective spread, as the higher the effective spread, the higher the inward FPI flows, and vice versa. Results on the effects of the bond effective spread on FPI show that as long as the bonds are above the investable grade, investors are not discouraged by the cost of trading. Our findings thus confirm that FPI inflows are predisposed on liquid and efficient host country financial markets. Further, the entrance of foreign investors in the host country’s domestic financial markets, leads to the enhancing of liquidity in the local market, thus increasing risk sharing between local and foreign investors.

Author Biography

Patricia Lindelwa Makoni, University of South Africa

Professor of Finance: UNISA; Department of Finance, Risk Management and Banking

References

Abankwa, S. & Blenman, L.P. (2021). Measuring liquidity risk effects on carry trades across currencies and regimes. Journal of Multinational Financial Management, Volume 60. 100683. DOI: https://doi.org/10.1016/j.mulfin.2021.100683.

Abu Shanab, S. (2017). The effect of foreign portfolio investment (fpi) on capital market indices (evidence from Amman stock exchange). International Review of Management and Business Research, 6 (4): 1469-1477. Available from https://www.irmbrjournal.com/papers/1513074842.pdf

Al-Smadi, M. O. (2018). Determinants of foreign portfolio investment: the case of Jordan. Investment Management and Financial Innovations, 15(1), 328-336. DOI: http://dx.doi.org/10.21511/imfi.15(1).2018.27

Amihud, Y. & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, Volume 17 (2). 223-249. DOI: https://doi.org/10.1016/0304-405X(86)90065-6.

Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects. Journal of financial markets, 5(1), 31-56. https://doi.org/10.1016/S1386-4181(01)00024-6

Bernstein, P. (1987). Liquidity, stock markets, and market makers. Financial Management, 54-62. DOI: https://doi.org/10.2307/3666004

Boehmer, E., Saar, G., & Yu, L. (2005). Lifting the veil: An analysis of pre?trade transparency at the NYSE. The Journal of Finance, 60(2), 783-815. DOI: https://doi.org/10.1111/j.1540-6261.2005.00746.x

Branson, W. (1970). Monetary policy and the new view of international capital movements. Brookings Papers on Economic Activity, (No. 2, 1970). Available online from: http://brookkings.edu/wp-content/uploads/.1970/06/1970b_bpea_branson_krause_kareken_salant.pdf

Errunza, V. (2001). Foreign portfolio equity investments, financial liberalization, and economic development. Review of International Economics, 9(4), 703-726. DOI: https://doi.org/10.1111/1467-9396.00308

Goldstein, I., Razin, A., & Tong, H. (2008). Liquidity, institutional quality and the composition of international equity outflows (No. w13723). National Bureau of Economic Research. Available online from: https://www.nber.org/system/files/working_papers/w13723/w13723.pdf

Haider, M. A., Khan, M. A., Saddique, S., & Hashmi, S. H. (2017). The impact of stock market performance on foreign portfolio investment in China. International journal of economics and financial issues, 7(2), 460. Available from https://www.econjournals.com/index.php/ijefi/article/view/3979

Kirabaeva, K. (2009). International capital flows and liquidity crises. Working paper. Department of Economics, Cornell University, Ithaca, NY 14853. Available from https://www.nber.org/system/files/working_papers/w15599/w15599.pdf

Makoni, P. L. R. (2016). The role of financial market development in foreign direct investment and foreign portfolio investment in selected African economies (Doctoral dissertation, University of the Witwatersrand, Faculty of Commerce, Law and Management, Wits Business School). Available from https://wiredspace.wits.ac.za/jspui/bitstream/10539/23720/1/577649_PhD_thesis_29_November_2016_final.pdf

Makoni, P. L. R. (2018). FDI, FPI and Institutional Quality-Evidence from African Countries. Academy of Accounting and Financial Studies Journal, 22(5), 1-13. Available from https://www.abacademies.org/articles/fdi-fpi-and-institutional-qualityevidence-from-african-countries-7493.html

Makoni, P. L. (2020). Foreign Portfolio Investments, Exchange Rates and Capital Openness: A Panel Data Approach. International Journal of Economics & Business Administration (IJEBA), 8(2), 100-113. DOI: https://doi.org/10.35808/ijeba/458.

Makoni, P. L., & Marozva, G. (2018). The nexus between foreign portfolio investment and financial market development: Evidence from Mauritius. Academy of strategic management journal, 17(5), 1-14. Available online from https://www.abacademies.org/articles/the-nexus-between-foreign-portfolio-investment-and-financial-market-development-evidence-from-mauritius-7604.html

Marozva, G. (2020). Liquidity Mismatch Index and Banks’ Stock Returns, International Journal of Economics and Business Administration, Volume VIII Issue 4, 930-945. DOI: https://doi.org/10.35808/ijeba/641.

Marozva, G., & Magwedere, M. R. (2021). COVID-19 and Stock Market Liquidity: An Analysis of Emerging and Developed Markets. Scientific Annals of Economics and Business, 68 (2), 129-144. http://saeb.feaa.uaic.ro/index.php/saeb/article/viewFile/1310/217

Marozva, G., & Makina, D. (2020). Liquidity risk and asset liability mismatches: evidence from South Africa. Studies in Economics and Econometrics, 44(1), 73-112. DOI: https://doi.org/10.1080/10800379.2020.12097357

Marozva, G., & Makoni, P. L. (2018). Foreign direct investment, infrastructure development and economic growth in African economies. Acta Universitatis Danubius. Œconomica, 14(6), 90-102. http://www.journals.univ-danubius.ro/index.php/oeconomica/article/view/5059/4674

Mohd, N. A., Rahman, A. A., & Yaacob, M. H. (2018). The Impact of Asymmetric Information on Foreign Portfolio Investment Flows. International Journal of Business & Management Science, 8(2), 475-494. Available from https://www.semanticscholar.org/paper/The-impact-of-asymmetric-information-on-foreign-Mohd-Rahman/0ad51ba50e82690f8ef968d2d31eb0792a318b07

North, D.C. (1990). Institutions, institutional change and economic performance. Cambridge: Cambridge University Press.

Nxumalo, I. S. (2020). International capital inflows in emerging markets: the role of institutions (Masters dissertation, University of South Africa, Faculty of Economic and Management Sciences). Available at: https://uir.unisa.ac.za/bitstream/handle/10500/26992/dissertation_nxumalo_is.pdf?sequence=1

Shen, C. H., Lee, C. C., & Lee, C. C. (2010). What makes international capital flows promote economic growth? An international cross?country analysis. Scottish Journal of Political Economy, 57(5), 515-546. DOI: https://doi.org/10.1111/j.1467-9485.2010.00529.x

Singhania, M., & Saini, N. (2017). Determinants of FPI in developed and developing countries. Global Business Review, 19(1) 187-213. DOI: https://doi.org/10.1177/0972150917713280

Solnik, B. H. (1974). An Equilibrium Model of the International Capital Market. Journal of Economic Theory, 8, 500-524. DOI: https://doi.org/10.1016/0022-0531(74)90024-6

Tong, H., Razin, A., & Goldstein, I. (2007). Systemic Liquidity and the Composition of Foreign Investment: Theory and Empirical Evidence. In 2007 Meeting Papers (No. 290). Society for Economic Dynamics. Available at SSRN: https://ssrn.com/abstract=971220 or http://dx.doi.org/10.2139/ssrn.971220

World Bank. (2020). World development indicators (WDI) 2020. World Bank Publications. Available from https://databank.worldbank.org/source/world-development-indicators

Downloads

Published

2021-09-17

How to Cite

Marozva, G. ., & Makoni, P. L. (2021). The nexus between bond liquidity, stock liquidity and foreign portfolio investment. International Journal of Finance & Banking Studies (2147-4486), 10(3), 92–103. https://doi.org/10.20525/ijfbs.v10i3.1348

Issue

Section

Articles