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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.

thesis, Strathclyde University, U.K.,1998


CHAPTER NINE
CONCLUSIONS

8.1 SUMMARY OF FINDINGS

The core of this thesis has involved an examination of the Egyptian stock

market efficiency with a specific focus on the price performance of the privatised

initial public offerings. Recent structural changes of the Egyptian economy in 1991

permit testing hypotheses about how these changes have affected the behaviour of

Egyptian stock market in general and privatisation initial public offerings in

particular. A variety of theoretical and empirical conclusions resulted from

discussions and empirical analysis presented in the preceding chapters of this thesis

are enumerated below:

An analytical review of prior studies is provided in Chapter Two. The first

section of this chapter dealt with the underpricing phenomenon connected with the

IPOs. Numerous studies suggest that the initial return premium from underpricing

could be established by the close in the first day of trading. Many hypotheses were

introduced to explain the underpricing phenomenon. However, most of these

explanations can be criticised on the grounds of either the extreme assumptions that

are made or the unnecessarily complicated stories involved.

In the second section of Chapter Two, the performance of aftermarket returns

in the IPOs was scrutinised. A large number of studies surveyed indicated negative

returns between the first closing traded price and the close of trading twelve months

after issue. Whilst some evidence of IPOs prices rising in the aftermarket was also

apparent, this appeared to be less common than the declining performance of returns.

Some clarifications were presented in order to explain these reported positive and/or

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
negative returns. However, the poor performance of IPOs in the long-run makes the

new issues underpricing phenomenon even more of a puzzle.

Some conclusions were generated from the literature review. First, evidence

of long-run returns for IPOs was noticed to be less extensive than evidence of short-

run underpricing. Second, explanations for poor abnormal aftermarket returns were

relatively less developed than those for initial returns. Third, evidence of

underpricing and long-run performance of the IPOs were observed to be well

documented in the developed stock markets, however, it is not the case for

developing capital markets. Finally, the majority of the literature focused on the

private IPOs, whereas the privatisation sales in the emerging markets got only a

small consideration.

Then, a structural and institutional background to the Egyptian securities

market is presented in Chapter Three. During the period prior to the 1991 economic

reform, it was noticed that the private sector was in the early stages of development,

and the role of the stock exchange remained minimal. However, in studying the

current situation of the Egyptian stock market, it was observed that this market

achieved a high level of success. This success was reflected in: (1) the flow of

privatization, (2) the increasing volume of traded shares, (3) increasing the

efficiency of securities companies working in the capital market, and (4) increasing

overall stock market efficiency.

In analyzing the market microstructure, we noted that the structure of the

Egyptian stock market seems to be different in comparison with the developed

capital markets. This is of interest because some studies tend to use the trading

system per se to explain the price performance of the IPOs in the developed capital

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
markets. For example, a greater volatility in the initial period is thought to be caused

by investment bankers who want to underprice the IPOs in such markets. On the

Egyptian stock exchange, trading is performed through the floor-traders whose duty

is essentially clerical. Nowadays, they receive market orders and record them in the

computer. The quantities are negotiated on a bilateral basis. Unlike in developed

capital markets, where investment bankers buy and sell for their own accounts and

have an obligation to stabilise prices and supply liquidity to the market, the floor-

traders do not take a position in the stock transactions. They do not buy or sell stocks

in order to ensure price stability nor do they have the duty to do so.

Before examining the price performance of initial public offerings in the

Egyptian stock market, we intended to examine the whole market on the domestic

and international levels as a preliminary exploration, in Chapters four and five,

respectively. In Chapter Four, attempts were made to examine some time series

properties and standard assumptions of stock returns and prices using three years of

daily data on the eleven Egyptian stock indices. First, several basic tests were

employed for testing normality. All indicated that none of the indices has a normally

distributed return. This result justifies the fact that daily stock returns are not

normally distributed. In such a case, our results are well in line with what has been

reported in studies on other markets [ e.g. Frennberg [1994)].

Due to the existence of leptokurtic distribution in our time series, we

employed a GARCH model in order to describe the process of stock returns in the

Egyptian financial market. The findings show that the variance of Egyptian stock

returns is time-varying in the GARCH context. We also analyzed the integratedness

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
of the volatility of asset returns. The empirical results indicate that the volatility of

Egyptian stock returns is integrated.

Then, in order to test the stationarity of the Egyptian stock returns, unit root

tests developed by Dickey and Fuller (1979) were initially applied. Second, we

conducted the variance-ratio test of Lo and MacKinlay (1988). The results provided

support that there is a relatively significant stationary component. Such stationarity

suggests the presence of successful smoothing for these series. It is suggested that

smoothing may reduce volatility of financial series but exhibit significant serial

correlation. The latter was found to be negative, suggesting that the stock returns

follow a mean-reverting process. The important conclusion of this evidence is that

there are components in past returns that can be used to predict future returns;

therefore, returns do not follow random walks.

Since the random walk hypothesis is not equivalent to market efficiency, we

conducted the test of efficiency using recently developed techniques from the time

series literature. In particular, unit root and cointegration techniques were used to test

the concept of static efficiency introduced by MacDonald and Power (1993) for

individual share price indices. Amongst the results reported in this Chapter is the

finding that disaggregate stock price indices of the Egyptian Stock Market are

cointegrated which is interpreted as a violation of static efficiency. It is suggested

that such cointegration may either reflect the consequences of noise trading or

variable equilibrium expected returns.

Since Chapter four was constructed to examine the efficiency of the Egyptian

stock market from the domestic point of view, we assigned Chapter five to look at

the issue of its internationalization among eighteen emerging stock markets during

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
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the period from January 1994 to December 1997. Considering the opening up of the

Egyptian equity market during the 1990s, it is expected that there is increasing

interest in investing in this market. The weekly stock indices of the eighteen

emerging equity markets examined in this Chapter all have a unit root, indicating that

all the weekly stock prices follow a random walk.

The Engle-Granger two-step methodology and the multivariate Johansen’s

cointegration tests were performed on these prices. The findings show that the

eighteen emerging markets are cointegrated, indicating Granger-Causality in levels

and suggesting of inefficiency. However, the results reveal an absence of any clear

evidence of cointegration among the Middle Eastern markets and also among

Mediterranean Rim markets. This finding implies that: (1) the international

diversification among these markets would be effective because the country risk can

be diversified away, (2) investors who want diversified portfolios may be encouraged

to invest in these markets, and (3) there is an evidence of efficiency due to the

absence of Granger-Causality in levels. However, because the test of efficiency

requires an explicit modelling of the trade-offs between risk and returns, we have

assigned the remaining three chapters to investigate the efficiency of the Egyptian

stock market by concentrating on the privatized initial public offerings.

Chapter six examined the initial returns in the primary market of Egyptian

PIPOs. Such initial returns were found to be approximately 15 % across time and

securities. The observed distribution was heavily skewed and had a median of 13 %.

The level of underpricing seemed to be high and privatised companies might have

lost money on the table. As a result, we investigated three hypothesis which were

proved, in the literature, to explain the positive initial returns to private IPOs.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
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However, they were unsuccessful in explaining even a small part of the initial returns

to the Egyptian privatisation sales.

Moreover, in Egypt, it is difficult to apply the explanation of Tinic (1988)

that the underpricing is a protection against legal liability. That is, the implications of

legal liability are quite different in Egypt relative to the U.S. For example, the claims

for compensation due to lack of due diligence are much more difficult to carry out.

Explanations other than the risk of legal liabilities might be more appropriate to

explain underpricing in Egypt.

Thus, we may suggest that the institutional feature of the Egyptian Capital

Market -the listing requirements of the Egyptian Stock Exchange and Capital Market

Authority, together with barriers to entry to stockbroking- provided the market

structure which facilitated underpricing. Thus we expect underpricing to be

eliminated or reduced, at least when membership restrictions of the Egyptian stock

market lapse.

Furthermore, it can be suggested that early sales of the privatised IPOs may

be deliberately underpriced in order to convince the market to absorb larger sales and

reduce the risk borne by the government. That is, it can be argued that the

underpricing is consistent with a signalling argument, since the privatised firms are

exposed to greater policy risk, and tend to be large and well known relative to private

IPOs. In other words, underpricing may signal commitment because an uncommitted

government cannot expect higher proceeds from a subsequent sale, and is therefore

not willing to underprice the initial sale.

Having considered the underpricing phenomenon, Chapter seven dealt with

describing and analysing the pattern of returns and risks of the Egyptian PIPOs

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
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during the first year of trading. The increase in PIPOs prices over the first few weeks

of listing in the Egyptian Capital Market may be consistent with some adjustment

processes for the initial underpricing suggesting efficiency in such market. However,

from the results in Tables 7-2 (Panel B) and 7-3 (Panel B) there is some evidence

that insignificant positive excess market returns exist, on average, between the close

in the first day of listing and the close in the 4th week of listing. These insignificant

positive returns may be caused by a number of initial subscribers selling stocks for

profit-taking purposes so that the PIPOs stocks are subjected to downward price

pressure.

In addition, it can be suggested that such price behaviour is attributed to a

speculative factor. That is, the early positive excess market returns in the aftermarket

may result from speculative bubbles which burst in subsequent trading in the post

listing period giving rise to negative excess market returns. Two explanations could

be provided for the existence of speculative ‘bubbles’ or ‘fads’. First, the Egyptian

government may attempt to place shares in strong hands rather than weak hands. The

former group retains the stock for a significant period of time and artificially

decreases the supply of stocks in the aftermarket forcing market prices upwards. The

second explanation might based upon government artificially stimulating demand for

newly listed stocks by selling shares to small, risk-oriented and generally uninformed

investors in the aftermarket period.

Finally, the results in the long-term seem to support the hypotheses regarding

the behaviour of the mean systematic risk after-listing. Thus, the mean beta declines

after-listing and varies around the market beta of 1. Moreover, the mean beta in the

initial period is higher than the mean beta in the after-market as hypothesised. The

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
mean beta in the Egyptian PIPOs market thus appear to behave nearly in a similar

manner to the risk behaviour in other markets.

In conclusion, although, in Egypt shares are not allocated to the investment

bankers to the offerings, it seems that the market for privatisation initial public

offerings is subject to considerable speculative activity. However, this does not

indicate that the Egyptian PIPOs market is seriously deficient relative to other

markets. This argument is given because a substantial body of work indicating that

the form of aftermarket returns and risks observed in the Egyptian market also occurs

in other equity markets.

Chapter eight, which is the final empirical chapter, examined the aftermarket

efficiency of the Egyptian PIPOs. The results in this chapter supported both the

weak-form and semistrong-form of the Efficient Market Hypothesis of the PIPOs in

the Egyptian Capital Market. Testing the weak-form of the EMH, first, the results of

regression techniques for both short-term and long-term returns showed that the

correlation coefficients were not statistically significantly different from zero at the 5

% level whether for the sample as a whole or for the sub-groups.

Second, the results of the non-parametric test (runs test) showed that prices of

the PIPOs change at random. Our result was based on the standardised normalised

variable (Z), which was calculated to test the statistical significance of the difference

between the actual and the expected number of runs, and which was not significantly

different from zero in both the daily and weekly data. As a result, based on the

parametric and non-parametric tests used in this study, we conclude that the weak-

form efficiency in the Egyptian initial public offerings market could not be rejected.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
Similarly, in testing the semistrong-form of the EMH, the main conclusion of

our analysis, based on daily analysis or weekly analysis; or based on market-adjusted

or risk-adjusted excess returns models; supports that the aftermarket of Egyptian

PIPOs is efficient in the semi-strong form sense.

Although these findings for Egypt are similar to the developed capital market

patterns, these findings must be interpreted cautiously because of the small sample

size and the fact that the most IPOs are concentrated during a fewer years. These

phenomenon exist in nearly all markets except the UK and the U.S.

8.2. RECOMMENDATIONS AND SUGGESTIONS FOR FURTHER RESEARCH


An examination of the efficiency of the Egyptian stock market, in general,

and the privatised initial public offerings, in particular, has been conducted in this

thesis. It is believed that such study provides a number of benefits to government,

investors, and academics interested in emerging equity markets. For instance, the

following recommendations can be considered by Egyptian policy and decision

makers, investors and academics.

 For the Government:

1. Government is recommended to use underpricing of early sales to encourage

individuals to participate in later sales.

2. Government is recommended to justify to its political opponents and supporters

any decision to sell and to underprice.

3. Government is recommended to enhance the marketability of public companies

by solving their basic problems.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
4. Government is recommended to attract anchor investors to those companies

which are most in need of foreign capital and expertise. There are several

obvious advantages to selling to anchor investors.

 First, they have a greater concern for protecting their interest in the

company as their investments are more long-term in nature as opposed to

merely owning stocks.

 Second, in times of difficulty, as opposed to small-scale capital market

investors, most anchor investors have little choice but to work towards a

long-term solution even if this means providing companies with more

capital.

 Third, they bring managerial skills, technology, access to markets, and

greater capability to operationally restructure privatised companies.

5. Government is recommended to rearrange its priorities and reallocate its limited

resources so that pragmatic solutions can be found to the fundamental problems

of selling the less attractive companies.

6. Government is recommended to address the fundamental logic behind the

process of privatization itself.

7. Government is recommended to use the tax incentives to stimulate foreign

investment.

 For Investors

8. Investors who want diversified portfolios are recommended to invest in the

Egyptian equity market as well as other Middle Eastern markets, because these

markets are not cointegrated. Such a diversification would be effective because

the country risk can be diversified away.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
 For Academics

9. Since amongst the results reported in this thesis is the finding that disaggregate

stock price indices of the Egyptian stock market are cointegrated which is

interpreted as a violation of static efficiency. It was suggested that such

cointegration may either reflect the consequences of noise trading or variable

equilibrium expected returns. One way to resolve which of the two effects

dominates would be to construct a survey data base on agents’ stock price

expectations, in spirit of work done for foreign exchange markets (see, for

example, MacDonald and Torrance, 1990).

10. Since the Egyptian PIPOs market was exceptionally active in the sample period,

it would be argued that the results reflect a temporary overoptimism by investors

that may be turned into disappointment when they learned more about the IPO

firm’s prospects. Additional evidence from other countries is needed before the

results can be interpreted more conclusively.

11. Investment banker reputation may play a critical role in assuring investors that

aftermarket price support would be provided. This suggests that a fruitful area for

future research may be to investigate the relation between measures of

investment banker reputation and extent of price stablization provided.

Particularly interesting in this area is the issue of market penalties for investment

bankers that violate implicit stablization guarantees. Such an investment banker

may lose market share; there may also be an increase in the underpricing of

offerings done by the investment banker, reflecting the drop in investor

confidence.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
thesis, Strathclyde University, U.K.,1998
12. I have analysed the stock market returns in the first year after going public. My

suspicious, however, is that the underperformance does not extend much beyond

a longer period, based upon Ibbotson (1975) and Rao’s (1991) findings. Ibbotson

finds no underperformance in the fifth yea after going public, the last year that he

analyzes. Furthermore, Roa finds negative earnings announcement effects in the

first 3 years after going public, but not in years 4 through 6.

13. Only by extending the sample period beyond the 3 years of this thesis can

additional evidence be gained regarding some of the patterns that have been

documented. This extension may resolve the issue of the generality of my

findings.

14. Another issue that is unresolved in this thesis is the relation of the long-run

underperformance to the short-run underpricing. It is something of a mystery

why PIPOs are priced in a manner that results in such large positive average

initial returns. If the Egyptian government sets the offering price in a manner that

reflects the firm’s underlying fundamental value, it is even more of a mystery

why some offerings have extremely high initial returns.

15. I would recommend an extension of this study using transaction-to transaction

price changes, instead of the daily or weekly price changes that this study

employed. The advantages of the transaction price changes are the following:

 Theoretically, investment bankers effects on transaction price changes are

much more significant.

 It will take into account the effect of volume on the distribution of stock

price changes.

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Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D.
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 Transaction-to-transaction price changes can serve as a direct measure of

the impact of the investment banker on price variability.

16. Researchers are recommended to investigate the difference of stock price

reactions to announcements of new security sales between rights and

underwritten offers.

17. Researchers are recommended to investigate the differences in underpricing

between private IPO and privatisation sales in the developing capital markets.

18. Researchers are recommended to study the possibility of underpricing

phenomenon of convertible bonds and convertible preferred stock, particularly in

a case of privatisation sales.

19. I and other researchers are recommended to conduct a comprehensive survey to

explore and analyze the relationship between price performance of Egyptian

PIPOs and the size of new issue of security, the issues with higher risk, legal

liabilities arising from any false or inadequate information in the prospectus (for

misrepresenting the true value of the firm), the size of the firm, the firm's age, the

quality of a firm, the market conditions (such as: the level of presales in the

premarket, the level of interest in the premarket, and the size of minimum-sales

constraints), the uncertainty of the market demand for the issue, the market share

of the investment banker, the use of warrants compensation, the syndication

process, and ‘favouritism'.

While a number of further research obviously emerge from the suggestions

above, it is believed that findings in this study provide a valuable contribution to

existing capital market research. This contribution is emphasised by the significance

of the research issues analysed in this study and by the importance of the Egyptian

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equity market. It is anticipated that some of the suggestions in this study can be

adapted in further studies of the pricing of initial public offerings in other developing

capital markets. This would encourage to extend existing empirical findings and set

the documented conclusions in this study into a wider international evidence.

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