The relationship between

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Date

2011-05-31

Authors

Mwiinga, Killian

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Abstract

Stock markets in Africa are small, underdeveloped and generally undercapitalised by world standards. Until recently they have been perceived as too risky to invest in by external investors. The “old” perception of Africa as a “single country/block” is slowly receding and countries are starting to be viewed as individuals, while not necessarily overlooking the issue of the contagion effects of any regional business risks. As has been observed, there has been generally improved market performance in stock markets on the African continent in terms of historical average annual returns represented by market capitalisation, market liquidity and number of domestic listed companies over the period 1997 to 2007. However, this could be due to many factors. For countries to be attractive to external investors it is necessary to have investor-friendly policies that protect their investments while creating an environment that allows competition. In so doing, it is important to evaluate the macro-economic and micro-economic policies that the respective countries on the continent have. The sovereign credit ratings of countries are based on economic fundamentals whose rating affects the ratings of many companies or businesses in that particular country. The purpose of this study was to gain insight into whether a relationship exists between sovereign credit ratings and the performance of stock markets on the African continent with respect to market capitalisation, market liquidity and the number of domestic listed companies. As it would appear that the information in this study has not been documented previously for the African continent it may be regarded as a formative evaluation and addition to the body of knowledge of the relationship between sovereign credit ratings and stock market performance in Africa. The statistical analysis methodology was undertaken using Spearman’s rank correlation method, which uses a t-test statistic within a 95 % confidence interval to test the strength of this relationship and, based on this result, a conclusion could be made. The findings of the research are intended to iii help countries in Africa evaluate their policies so that they become more attractive to investors. A window period of five (5) years, (1999 to 2003), was used to analyse the data set for sovereign credit ratings. A similar, four (4)-year window period (2000 to 2003) was used for the comparison of the stock market indicators (market capitalisation, market liquidity and number of domestic listed companies). It was not possible to align the two window periods selected for the research as all the data sets published lack information for certain years. However, it was felt that as a trend – rather than an absolute correlation – was being sought, the validity of the research would not be unduly jeopardised. The result of the findings in this research was that there exists no relationship between sovereign credit ratings and the performance of the stock markets on the African continent with respect to market capitalisation, market liquidity and number of domestic listed companies. It became clear that the performance of African stock markets was influenced by factors other than an improvement or worsening in the macro- and micro-economic fundamentals of a country. The question remains: “What influences the performance of the stock markets on the African continent?” This is an important area for further research. The World Bank, through its implementing partner, the United Nations Development Programme, needs to review its current programme to promote stock markets on the African continent to see what areas require additional focus for this project to receive the attention needed. Alternatively, it could be that it is still premature to do so, considering that in 2007 only 20 countries had stock markets.

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MBA - WBS

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Sovereign credit ratings, Stock market

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