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Isabella Massa is a Ph.D. student at Ca’ Foscari University in Venice, Italy. This paper was largely written while she was an intern in the IMF’s Middle East and Central Asia Department. The authors would like to thank Klaus Enders, Nadeem Ilahi, Nicole Laframboise, Mohammed Omran (Cairo and Alexandria Stock Exchanges), and seminar participants at the IMF for helpful comments; Anna Maripuu for help with the data; Judith Rey for careful editing; and Mohammed Omran for providing data.
The Shuaa index includes the countries organized in the Cooperation Council for the Arab States of the Gulf (GCC), Egypt, Jordan, Lebanon, Morocco, Tunisia, and West Bank and Gaza. In addition to Egypt, several other countries contained in the index saw a speedy recovery after last year’s stock index correction, especially Morocco and Tunisia.
To some extent, this is mirrored by the fact that models relating stock market capitalization to macroeconomic variables have difficulties explaining the developments in recent years, hinting at possible misalignments between stock price indices and underlying fundamentals; see Billmeier and Massa (2007).
The correction in 2006 occurred simultaneously with, but was much more limited than those in other markets in the region, including Saudi Arabia and Jordan.
We would like to thank Mohamed Omran from the CASE for providing these data as well as data on the composition of the price index over time.
Another commonly used stock valuation measure is the price-to-book ratio. We were, however, not able to obtain a time series for this indicator for the CASE 30 index.
P/E ratios for major economies have been between 33.6 (Canada) and 18.4 (United Kingdom) just before the 1998 correction, and between 14.7 (France) and 24.0 (United States) immediately after; see OECD (1998). Dynamic emerging markets often trade at a premium.
Saadi-Sedik and Petri (2006) show that the P/E ratio on the Amman Stock Exchange reached a value of about 45 in 2005. P/E ratio in Saudi Arabia before the 2006 correction reached a value of 80.
This appears to be chronologically related to the floating of the Egyptian pound on January 29, 2003.
Shiller (1981) uses real annual data for dividends and prices from the S&P Composite Index for the years 1871-1979, and from the Dow Jones Industrial Average for the years 1928-1979.
The Gordon growth model appears a good choice, though, to compute the fundamentals of the CASE 30 index given that the index includes, over much of the observation period, a high percentage of slow-growing companies like utilities, financial services, and real estate companies for which g < i is more likely to hold (see Figure 1).
Marsh and Merton (1986), and Kleidon (1986), among others, argue that Shiller’s variance bounds test is unreliable since it is based on the inappropriate assumption of stationarity for the dividend process. However, Shiller’s methodology is still widely used in the literature since tests that adjust for dividend nonstationarity tend not to yield more consistent results.
Both variables have been tested for a unit root using the conventional tools (Augmented Dickey Fuller and Phillips-Perron tests). Only for one model (Augmented Dickey-Fuller, including a trend), the null of a unit root in the level of the dividend index can be rejected at the 5-percent level. There were no indications of unit roots in first differences. The results are subject to the usual short-sample criticisms and are available from the authors.
See Diba and Grossman (1988a, 1988b) and Johansen (1991). Brooks and Katsaris (2003) offer evidence that price developments on the London Stock exchange in the second half of the 1990s have not been consistent with economic fundamentals.
As a sensitivity test, we experimented with a different sample break (December 2003). The results are broadly similar in that (i) there appears to be evidence for one cointegrating relationship during the first period; (ii) the evidence for a cointegrating relationship in the second period depends strongly on the amount of lags chosen for the empirical model; and (iii) the CASE 30 index is weakly exogenous.
This also includes the Egyptian S&P index on a U.S. dollar basis. The Egyptian local-currency index corresponds to the CASE 30 index.
The main results hold when using local indices (e.g. DAX, CAC40, FTSE100, MIBTEL), as the S&P index closely tracks these indices. The results have been omitted due to space constraints.
See the discussion in SSP on the trade-off between using U.S. dollar versus local currency indices.
Results have been omitted but are available from the authors. See SSP for results on most indices used in this paper.
SSP found that the Saudi stock market yielded the highest average return, at 0.53 percent per week. These figures, however, predate the major correction in Middle East stock markets in 2006, which was more pronounced in Saudi Arabia.
Although the test statistics are significant, the largest eigenvalue is rather low, implying a partial correlation
of just above 20 percent between the linear combination of Xt−1 and the stationary process ∆Xt
In fact, we are able to reproduce their results by restricting the sample appropriately.