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Research on the paper was initiated when I was in the Policy Development and Review Department. I would like to thank Steven Dunaway and Robert Rennhack for their suggestions and comments. I remain responsible for all remaining errors. The views expressed in this paper do not necessarily represent those, of the International Monetary Fund.
These are a group of 38 countries in Africa, Asia, Europe, Latin America and the Middle East. However, not all of these countries have an actively traded stock market or significant market capitalization, e.g, the IFC includes only 25 of these countries as part of their Emerging Stock Market Data Base.
The data base includes two European markets, Greece and Portugal; two Middle Eastern countries, Jordan and Turkey; six Latin American countries, Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela; nine Asian countries, China, India, Indonesia, Korea, Malaysia, Pakistan, Philippines, Taiwan, and Thailand; and Nigeria and Zimbabwe in Africa.
See Shiller (1984) for a survey of the issues involved in this area. Summers (1986) provides more recent evidence. DeLong et al. (1990) and Campbell and Kyle (1993) provide some newer explanations to this phenomena. However, despite the diversity of possible explanations it is still an open issue with some degree of consensus over the existence of "excess volatility."
Allen and Gorton, 1993, have shown how "churning bubbles" can persist with rational behavior. These bubbles occur when there are asymmetric information between investors and portfolio managers with the managers "churning" their client’s portfolio to perform better than the market.
This is a convenient way to introduce differences among investors. Alternatively, one could, with little modification, introduce differentiation based on the liquidity needs of each investor. Qualitatively, the results in this section are invariant to the exact specification of the differences among investors as long as they affect investor trading in an idiosyncratic manner.
The presence of the liquidity trades as in other models prevent the breakdown of the market. However, instead of assuming noise trading one could have introduced a nonmarketable asset among the traders endowments whose return is at least partially correlated with x (see Bhattacharya and Spiegel 1989, Pagano, 1986). In this model like in the original Kyle set up, the liquidity traders provide the profits to the informed traders. Without these traders, arbitrageurs would, in any rational expectations equilibrium, be able to deduce all the private information of the informed traders and thereby set the price correspondingly to eliminate all possible profits.
In the original Kyle (1985) model instead of the arbitrageurs there is a market-maker who observes the total order submitted and sets the price such that her expected profits, conditional on the observance of the aggregate orders, is zero. The equilibrium condition that determines the price of the asset is not altered whether a market-maker or arbitrageurs are assumed to eliminate any excess profits based on public information.
This condition also ensures that given the structure of the market, the equilibrium price is efficient. For a more detailed analysis see Kyle (1985).