Are There Smaller Leverage Effects in Less-Developed Markets? Evidence from an Oil Exporting Country

Abstract

Problem statement: This study uses daily data from the Tehran Stock Market (TSM) to illustrate the nature of stock market volatility in an undeveloped and young stock market. Although most studies suggest that a negative shock to stock prices will generate more volatility than a positive shock of equal magnitude but there is no evidence of asymmetric effect in TSM. Determine the nature of stock market volatility in an oil exporting country. Approach: Trading in Tehran Stock Market (TSM) is based on orders sent by the brokers. The data consist of 2375 daily observations of the closing value of the Tehran stock market from 3/30/1998 to 5/04/2007. Our empirical finding shows that the unconditional variance is 0.18 but visual inspections of the time series suggests that volatility of the stock return rate displays the clustering phenomenon associated with GARCH processes. Results: The estimation and test results for all models suggest that the leverage effect term, γ, is not significant at 5% level. Although, in Asym. CARCH model based on normal distribution for errors, the estimated coefficient on the asymmetry term is -0.066 with a z-statistics of -1.749 recognized as significant at 10% level, but it has the wrong sign. It seems that good news and bad news has the same effect on stock prices in TSM, a result that is contradictory to other studies for developed countries. Conclusion: The estimated models containing TARCH, EGARCH, asymmetric CARCH and PARCH with different assumptions on error distributions suggest no strong and significant asymmetric effect. There are some reasons for this finding: (1) In Iran with Islamic laws, debt contracts are illegal or at least not enforced and Iranian firms do not have any financial leverage. As a result, we would expect to find smaller leverage effects in volatility in Iran than in the United States, for example. In deed the institutional differences with western financial markets manifest themselves in different return characteristics. (2) Stock prices in the TSM by regulation and intervention cannot exceed from some range. The strong serial correlation in returns necessitating long lags in the mean equations is possibly due to such regulations. (3) The history of TSM is very short compared to other stock markets and the information flow in this market is very slow. The estimated coefficients on the expected risk (as a measure of the risk-return tradeoff) are not significant. These findings suggest that the TSM is not efficient.