2 At the same time, retums on stock markets in emerging countries have been high; for example, the T1C composite index for Latin America was up 294.2 percent over 1988-1992, compared to ;08.4 percent for the S&P500. This may also have been a factor motivating the larger inflows of foreign equity. At the same time, however, the volatility (standard deviation) of rates of return has also been high reaching, for example, more than 100 percent for Argentina.

The increase of these equity flows to a number of developing countries and the opening up of their stock markets raise a number of issues. An important one is what the effect has been on the risk-return tradeoff in these markets of the removal of barriers, i.e., how much has the risk-return tradeoff changed. The purpose of this paper is to quantify the effect of barriers to access by foreign investors on stock prices and rates of return.

To answer this question, we use the newly created indexes by the IFC Emerging Markets Data Base (EMDB) on the degree of foreign access or "investability.' The IFC investability index captures the barriers to free access by foreigners for each stock (general inflow or outflows restrictions, general or sector-specific ownership restrictions, remittance restrictions, other exchange restrictions, restrictions on capital structure, etc.). These stock-specific indexes should thus be a good indicator of the relative importance of barriers across securities at a given point in time in one market or across a number of markets, or of changes in barriers over time.

Summarizing our results, we find a positive relationship between P/E-ratios and the degree of access for almost all the countries. For four out of the seven markets we study in detail, this result is robust to the inclusion of the world beta and the degree of international spanning of the domestic market. Only for Jordan and Mexico, however, is this result robust to the inclusion of the additional factor of the supply of stocks. For the relationship between rates of return and the investability index, we find evidence of a negative sign for only Jordan, which is also less robust. For other countries, we do not find that abnormal stock returns are related in a systematic fashion to a stock's investability index.

The outline of this paper is as follows. Section one presents an overview of possible analytical frameworks. Section two describes the data we use and provides some statistics on the rates of return. We then perform the Stehle (1978) test for market segmentation or integration for each market to investigate whether these markets indeed show signs of being segmented. Section three provides the empirical results of these tests of market integration and market segmentation. We then describe in the next section the concept of the investability index as developed by the IFC and provide some statistics on the investability indexes. Section five perform the tests on the (cross-sectional and time series) relationship between the P/E-ratio and the abnormal rate of return on an individual stock on the one hand and the level of its investability index on the other hand and performs some robustness tests. Section six concludes.