Segmentation of capital markets

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1.        Segmentation of capital markets


1.1    Concept of capital market segmentation


Market segmentation refers to subdividing a larger market into smaller segments according to shared consumer attributes or characteristics. When markets are divided by geographical boundaries, the process is referred as geographic market segmentation (DeThomas & Grensing-Pophal 2001, p.68), also there are other attributes and characteristics that divides the capital market into smaller sub markets that will also have relative implications to the investors.


1.2    Factors resulting in capital market segmentation


1.2.1            Government regulations


The history of market interventions suggests that capital market regulations are effective in large part because they segment the domestic capital market from international markets and capital flows. Segmentation aims to protect the domestic economy from the volatility produced by capital market liberation and globalization (Stiglitz & Ocampo 2008, p.33). For example, for making portfolio investment in India, one should be registered either as a foreign institutional investor (FII) or as one of the sub-accounts of one of the registered FIIs. Both registrations are granted by the market regulator, SEBI. Foreign institutional investors mainly consist of mutual funds, pension funds, endowments, sovereign wealth funds, insurance companies, banks, asset management companies etc. At present, India does not allow foreign individuals to invest directly into its stock market. However, high-net-worth individuals (those with a net worth of at least $US50 million) can be registered as sub-accounts of an FII ( 2011). Similarly, Japanese and Korean markets also had restrictions on the foreign ownership of equity and allowed only limited participation by foreign ownership of equity and limited participation by foreigners in these market. And also Japan restricts equity purchases by foreigners in certain selected industries and firms considered to be in the national interests (Choi &  Doukas 1998, p. 62). There are advantages and disadvantages of the segmentation by the political and government forces but in the end, this segmentation will continue to exist for a long term and it is important the investors know well about the restrictions in a oversea financial market.


1.2.2            Differing investor perceptions and preference


The differing investor perceptions and preferences can be seen in the fact that bonds offered by a variety of high quality sovereign issuers, irrespective of credit rating, have generally enjoyed different preferences. For example, debt issued by prime issuers such as the Kingdoms of Denmark, Sweden, Finland and the Government of New Zealand have traded at a significantly higher yield in the Yankee market than in the Eurobond market. In contrast, Canadian issuers have languished in the Eurobond market because of the proximity of the United States and Canada (Das 2006). Similar situations could also be found in other countries as many investors are ordinary people and they also have positive sentiment towards their countries which could be extended to the financial products issued by the governments.


1.2.3            Extent of flexibility


Modigliani and Sutch (1966) developed the preferred habitat hypothesis, which asserts that investors and borrowers that have a preference for particular maturities. Some borrowers such as manufacturers may be financing long-lived projects which may be more suited to financing with long-lived bonds rather than, say, by using commercial paper. Insurance companies and pension funds may have obligations with long maturities. Other borrowers such as banks have short lived liabilities and therefore may prefer assets with shorter maturities. Thus, different groups of borrowers and lenders have different preferences concerning the preferred maturities of the instruments they desired (McInish 2000, p.227). Such differences in different financial products in term of short lived liabilities or long lived liabilities could be traced back to the different needs of the individual and institutional investors. For example, when a mother invests the tuition intended for her child to spend in the near future, then she may probably choose the short lived bonds and other short lived financial products and also high risk financial products would not be preferred by the mother in most cases because she can not afford to lose the money in the investments.


1.2.4            Lack of enough of information about the target market


Investment barriers could also consist of investors’ inhibitions due to the lack of information regarding a target market and its companies. This often results in the unwillingness of local investors to invest in foreign companies. This home bias still seems to be distinct in the investment behaviors of the majority of the investors even in the developed markets. Based on the study by Kilka (1998), compared to an ideal allocation of only 4%, German investors invest 88% into German assets (Hommel 2011). Actually the unwillingness as shown by the investors to get to know the oversea strange financial market could be understood as that there are cost to get to know the market in term of time and energy and also different culture and languages. Especially when there is a lack of information about the possibility of the high return in the foreign market, the psychological cost could stop the investors from getting to know the target market.


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