An investigation of stock price dynamics in emerging markets

The emergence of stock markets in former centrally planned economies poses a significant problem to financial economists and policy makers in that price movements in these markets are not well explained by conventional capital theory. The opening of stock markets brings about a new equilibrium value (P) over cap for the firm. Shares are floated on an estimate of (P) over cap, and buyers of these shares and individuals trading in the secondary market are also obliged to do so on the basis of their estimates of this magnitude. At any time, the market price of the firm's shares then reflects the market's best guess of what its value would be in the new equilibrium, and information on which to calculate estimates become more readily available as the stock market matures. This paper presents a stochastic price model which takes all of these factors into consideration. The model also provides a theoretical foundation underlying the pronounced trends of prices in emerging stock markets, and explains why they appear to be so volatile. (C) 1998 John Wiley & Sons, Ltd.