Cost of trading, effective liquidity measures, and components of the bid-ask spread in the emerging stock market of Ukraine
The thesis studies aspects of the cost of equity trading in the emerging stock market of Ukraine. The market is quite new (opened in 1997 but started to operate actively only in 2004) and little research on this market has been done so far. The market appears to offer lucrative investment opportunities that attract attention of both Ukrainian and foreign investors but the cost of trading Ukrainian stocks is quite high and can considerably decrease the returns to investors. The empirical part of the thesis is based on the transactions data from the main trade floor in Ukraine, PFTS, for 59 Ukrainian stocks during 2004-2006. The cost of equity trading in Ukraine is found to be quite high compared to many other stock markets, both developed and emerging. An in-depth study has shown that the medium-sized trades are the cheapest to execute, followed by large and then small trades. The reason for the pattern is seen in the price improvement suggested by brokers to the larger, more valued customers in order to keep the business with them and is in line with the findings in other literature for dealership markets (Reiss and Werner (1996), Hansch et. al (1999), and Huang and Stoll (1996)). The average cost of institutional sale trades exceeds the average cost of institutional buy trades at any market condition (falling, neutral, or rising), which is a puzzling result given that sales are often found in the literature to be more expensive in falling market, while purchases are more expensive in rising market. The efficacy of a number of measures of liquidity is studied. In line with findings for other emerging markets, it is shown that the proportion of zero daily returns (Lesmond (1999)) and the proportion of no-trading days are the most reliable liquidity measures for the Ukrainian stock market. Turnover, a measure widely applied in literature for developed stock markets, has a very small power for measuring liquidity in Ukraine. The spread components are estimated by applying three spread decomposition models most frequently referred to in literature: Stoll (1989), Glosten and Harris (1988), and Huang and Stoll (1997). The estimation results show a low importance of the asymmetric information component, which is surprising given that insider trading is considered a serious risk in Ukraine. To present the importance of incorporating the transactions costs into portfolio return analysis, a momentum trading strategy is examined. It is shown that momentum portfolio returns decrease considerably when the cost of trading is taken into account.