# **Srnmary**

Equity portfolio flows to developing countries have increased sharply in magnitude in recent years. Total equity flows to developing countries were estimated to be $13.0 billion in 1992, quadruple that of three years earlier.

The increased importance of direct equity purchases by foreigners in emerging stock markets may in part be attributed to the progressive removal of formal barriers by developing countries on foreign participation in their stock markets. Many developing countries have in recent years removed restrictions on foreign ownership, liberalized capital account transactions, and in general have made it easier for foreigners to access their markets.

This paper investigates stock performance in emerging markets in relation to this increase in their accessibility by foreign investors. As a measure of the degree of accessibility by foreigners to emerging markets stocks we use the investability index created by the Emerging Market Data Base (EMDB) of the IFC. The IFC investability indexes capture for each stock the legal barriers to free access by foreigners (general inflow or outflows restrictions, general or sector-specific ownership restrictions, remittance restrictions, other exchange restrictions, restrictions on capital structure, etc.). These indexes should thus be a good indicator of the relative importance of legal 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.

To determine if barriers in general (both legal and other) are important, we test whether 16 emerging markets are segmented from or integrated with the global equity markets, using data for the 1989-1992 period. Using the Stehle (1977) model, we reject the hypothesis that emerging markets are integrated with world capital markets (for most emerging markets) and fail to rLject the hypotheses that markets are segmented (for all emerging markets). We interpret this as evidence that barriers curtailing access by foreigners to emerging markets in general have been important.

We next investigate whether legal barriers to access--as captured by the invesmability indexes and distinct from other, informal barriers--are the main reason why emerging markets are found to be segmented from the global equity markets for this period. We find, on a crosssectional basis, that for most emerging markets there is a strong relationship between a stock's price-earnings ratio (P/E-ratio) and the investability index of the stock, suggesting that barriers to access by foreigners have a negative impact on stock prices and hence raise the cost of capital of listed firms. For four markets, this result is robust to the inclusion of the world bcta and the uniqueness of domestic stock market risk (the degree of international spanning of the domestic market), factors which in theory should also play a role in determining the effects of barriers. This result is also not influenced by the time-series effects of general market price movements as it is robust to a standardization of the stocks' P/E-ratio with the emerging market's general P/E-ratio.

A significant negative relationship between the investability index and a stock's rate of return is, however, only found for Jordan. This is probably because the effects of changes in