MASTER OF SCIENCE IN
FINANCE
MASTER
’
S FINAL WORK
D
ISSERTATION
A
S
TOCK
M
ARKET
I
NDEX OF A
P
ERIPHERAL
E
CONOMY
:
THE
C
ASE OF THE
P
ORTUGUESE
B
ANKING
S
YSTEM
(1870-1913)
M
IGUEL DA
C
OSTA
C
ORADO
MASTER OF SCIENCE IN
FINANCE
MASTER
’
S FINAL WORK
D
ISSERTATION
A
S
TOCK
M
ARKET
I
NDEX OF A
P
ERIPHERAL
E
CONOMY
:
THE
C
ASE OF THE
P
ORTUGUESE
B
ANKING
S
YSTEM
(1870-1913)
M
IGUEL DA
C
OSTA
C
ORADO
S
UPERVISOR:
A
MÉLIAB
RANCOR
ITAM
ARTINS DES
OUSAI
Acknowledgements
I would like to express my sincere thanks to the Professors Amélia Branco and Rita Martins de Sousa for all the support, availability and knowledge sharing they have shown during all the steps of this work. The two together form an extraordinary team to work with and this thesis was not possible without their help.
II
Glossary of terms
BdP: Banco de Portugal
BCL: Banco Comercial de Lisboa BL: Banco Lusitano
BLA: Banco de Lisboa & Açores BNI: Banco Nacional Insulano BNU: Banco Nacional Ultramarino BPV: Banco do Povo
BVL: Bolsa de Valores de Lisboa CCC: Companhia de Crédito Comercial CCI: Caixa de Crédito Industrial
CGD: Caixa Geral de Depósitos
CGCPP: Companhia de Crédito Predial Português GDP: Gross Domestic Product
GHES: Gabinete de História Económica e Social IFC: International Finance Corporation
LSE: Lisbon Stock Exchange
SGAFP: Sociedade Geral Agrícola e Financeira de Portugal WWI: World War I
III
Abstract
Studying financial and economic history teaches us the significance of context in modern economics. Several times historical information has shown to be important in addressing problems of present times and it is in this way this study is developed.
This research is useful to fulfil a historical gap, due to the lack of studies and collected data, of the Portuguese capital market during the 19th century and beginning of
the 20th century.
Studying how developed a country’s stock exchange is and how it performs, as well as how certain sectors, namely the banking sector, impacted on its progress can be considered an asset for the history of the Portuguese capital markets.
The subject of this study concerns the capital markets, particularly the Lisbon Stock Exchange and the Portuguese banking sector during the period of 1870-1913. The main objectives are to investigate the behaviour of volatility, profitability and liquidity indicators on a peripheral capital market within an international economy in integration, where some internal crises occurred.
Given this starting point several hypothesis will be tested: how volatility and profitability are affected during a crisis period? Are these two indicators correlated during critical events? What is the behaviour of liquidity during crises? What was the influence of the international economic environment in the behaviour of the financial indicators on the Lisbon Stock Market?
IV
The findings regarding the three indicators studied allowed to prove that the volatility present was not the reason for any of the crises, but a result of them. The returns were low as well as the number of days with transaction during an identified crisis period. Mainly due to the crisis periods and their repercussions over the sectors represented on the stock exchange, it is possible to infer that inside events in the country have a deeper impact at a financial level than external ones. The low financial integration of the Portuguese capital market explains this conclusion.
The sequence of events that started in 1876, aggravated by a complex crisis in 1891 and the political instability created after 1910 affected both the stock market and the banking system culminating into a conturbated “belle époque”.
V
Index
1. Introduction ... 1
2. Theoretical Survey ... 3
2.1. Financial Development and Economic Growth ... 3
2.2. Financial Crises ... 4
2.3. Emergent and Developed Markets: Volatility, Liquidity and Profitability ... 6
3. The Lisbon Stock Market ... 9
3.1. The Lisbon Stock Market: BVL ... 9
3.2. The Portuguese Banking System ... 10
3.3. Events and Effects on the Stock Market ... 12
4. Empirical Analysis ... 13
4.1. Definition and sample analysis ... 13
4.2. Assumptions ... 14
4.3. Methodology and Hypothesis Definition ... 15
4.4. Results ... 19
5. Conclusions and Research Limitations... 25
5.2. Research Limitations ... 26
6. References ... 27
7. Appendix ... 30
Figure 1 - General Index Results ... 33
Figure 2 - Banking Sector Index Results ... 33
Figure 3 - Banking Sector Index Liquidity Results ... 37
VI
Table II - Indicators Variation ... 30
Table III - Sample banks activity period ... 30
Table IV - Periodicity of data ... 31
Table V - General Index Results ... 31
Table VI - Banking Sector Index Results ... 32
Table VII - General Index t-Test for Crisis Years ... 34
Table VIII - Banking Sector Index t-Test results for Crisis Years ... 34
Table IX - Banking Sector Index Liquidity Results ... 35
Table X - Kondratiev and Juglar Cycles ... 38
Table XI - General Index Results and Kondratiev/Juglar Cycles ... 38
1
1. Introduction
Studying financial and economic history teaches us the significance of context in modern economics. Several times historical information has shown to be important in addressing problems of present times and it is in this way this study is developed.
When compared to other countries like the Netherlands, Belgium, United Kingdom or the United States of America it is observable that Portugal stayed behind in international studies about capital markets. This research is useful to fulfil this historical gap, due to the lack of studies and collected data, of the Portuguese capital market during the 19th century and beginning of the 20th century.
During the second half of the 19th century and the beginning of the 20th century, Portugal went through an arduous process of economic and financial development. Over this period the country developed its poorly sustained banking system as an attempt to back up a newly created industrial society. However, it suffered the consequences of a banking crisis in 1876 that forced the closure of a great number of financial institutions that operated in the country. Not twenty years had passed from this date, and by 1892 a sovereign debt crisis led the nation to a partial default and to declare National Treasury bankruptcy in the same year.
After these two financial setbacks, the country embraced the new century with a political crisis that lead to the casting off of the Constitutional Monarchy regime and the adoption of a Republic regime in 1910.
The uncertainty created by these three situations and the motives that lead to them, impacted on the financial development of the country as well on the banking system.
2
objectives are to investigate the behaviour of financial indicators on a peripheral capital market within an international economy in integration, where some domestic and external crises occurred.
Given this starting point several hypothesis will be tested. The first one concerns the volatility indicator and its behaviour as a consequence of critical domestic events – is it high during these events or it is not affected? The second question addresses profitability and how affected it is by the internal events under study. The following question concerns the correlation between this two indicators: are profitability and volatility negatively correlated during critical events? The fourth question regards liquidity and the influence of internal crises on this indicator: is liquidity lower during crises?
The previous hypothesis focused on the internal events that affected Portugal during the period under analysis. The last question of this study addresses how the LSE acted in an international economy context: what was the influence of the international economic environment in the behaviour of volatility, profitability and liquidity on the stock market?
For this analysis a General Index listing a sample of companies on the stock market and a Banking Index listing only the banks, will be compared in terms of volatility, profitability and liquidity during this period.
The data needed to perform the study of both the general and the banking sector indexes is provided by Gabinete de História Económica e Social – ISEG within the project: Portuguese Capital Markets (1837-1913).
3
that occurred between the end of the 19th century and beginning of the 20th century.
Followed by a theoretical analysis of the different types of financial crises and their impact on the three indicators used to analyse the indexes considering the developed and semi-peripheral economies. To the second part of this work a contextualization of the LSE and the banking system is performed as well as the events that impacted on the financial markets in Portugal.
An empirical analysis of the data collected is presented in addition to the methodology and results obtained. To finish the main conclusions of this study are presented.
2. Theoretical Survey
2.1. Financial Development and Economic Growth
The economic growth, lived on Europe and overseas extensions during the 19th
4
The development of a truly global securities market occurred also during the second half of the 19th century. Securities moved out of the realm of government debt and entered the mainstream of economic activity (Michie, 2008).
If at first, banks worked as catalysts for industrialization, the research about the Belgium stock market development done by Nieuwerburgh (2006) showed that before 1873 the banking system was more important for economic growth in Belgium and, after this date, the stock market acquired more significance.
In general there are four essential institutional factors that underpinned a developed financial system: “the respect for property rights; an accounting and disclosure system that promotes transparency; a legal system that enforces arm’s length
contracts cheaply; and a regulatory infrastructure that protects consumers, promotes
competition and controls egregious risk-taking” (Rajan & Zingales, 2003). The development of financial markets allowed for more efficient ways of finance both private and public investments. Nevertheless, both financing systems, when developed, foster economic growth, capital accumulation and productivity growth (Levine & Zervos, 1998).
Therefore, if the financial system is fundamental to explain economic growth, it can be in the same way fundamental in explaining financial crises.
2.2. Financial Crises
Until World War I the market knew booms and busts in a context of capital mobility and financial integration (Bordo & Landon-Lane, 2010).
5
Due to their impact on the research topic, banking crises and sovereign debt crises need to be analysed. In the literature several definitions of what can be considered a banking crisis can be found.
For Reinhart & Rogoff (2009) there is the need to observe bank runs that lead to general bank failures within an economy and consequent closure, merger or takeover by the public sector; or in the event of no bank run when an important financial institution needs government support (being a sign that other financial institutions might follow similar outcomes). Expressive problems in the banking sector, where the outcomes are the erosion of a great part of all banking system collateral and consequent resolution by a fiscally underwritten bank restructuring are a landmark for this type of crises. If before 1914 there were no established lenders of last resort and illiquidity was the main problem, the following crises had some active lender or insurance backing the system (mainly after 1929), being bank insolvency the main concern (Bordo & Landon-Lane, 2010).
These definitions go towards the results presented by Demirgüç and Detragiache (1998) when they found that these specific crises are liable to happen when the macroeconomic environment is fragile, especially when the growth of the economy is low and inflation is high.
On the perspective of Scharwtz (1986) quoted on Bordo & Landon-Lane (2010) financial crises are confined to banking crises and these last ones are defined by a decrease in the monetary base.
6
Haan & Schoenmaker (2012) using the research done by Reinhart & Rogoff (2009) state that this sovereign default happens when an indebted government fails to meet interest or principal payments on its debt obligations. Also it should be stressed that if the loans are issued under another country’s jurisdiction, denominated in a foreign currency and held by foreign creditors we are in the presence of external debt. On the other hand, domestic debt is in local currency and held by domestic creditors.
This kind of incident can be identified when the ratio of public debt over GDP exceeds 100%, over a period of time (Betrán et al, 2011).
In what concerns the occurrence of this sovereign defaults, historical records show that they are not inherent of emerging countries and that only a small number of countries, within developed economies (United States, Canada, Australia) avoided government debt default (Reinhart & Rogoff, 2009).
These crises impact on the stock market of both emerging and developed markets affecting three main indicators: volatility, liquidity and profitability.
2.3. Emergent and Developed Markets: Volatility, Liquidity and Profitability
In this research the General Index and the Banking Sector Index, will be analysed taking into account the variables of volatility, liquidity and profitability, being therefore needed to understand what the literature identified over different studies and periods. Due to the nature of the Portuguese economy and its stock market, it is also important to contrast the behaviour of these variables and understand how they impact in a developed and emerging market.
7
market to achieve a certain level of activity that impacts on the global size of the economy. The IFC definition of emerging stock markets is based on two main characteristics: economic growth (if the market is based in a developing country) and market development (level of stock market capitalisation) (Battilossi & Morys, 2011).
Schwert (1989 a) regards stock volatility as reflecting the uncertainty about future payoffs and discount rates; changing over time and related to business cycles and financial crises. From his work some conclusions can be taken and expected to be observed: stock volatility increases during recessions and around major financial crises; bank failures are related with increased risk; and if on one hand the default risk for bank deposits increased in the period prior a banking panic on the other hand the volatility associated with stocks increased only during or after major crises being interesting to imply that stock market volatility was not the reason for these crises.
For liquidity, when transaction costs are lower in order to trade equities in the market we are in the presence of more liquid stock markets. This facilitates long term investment with projects that provide higher returns and with that enhance productivity growth (Levine & Beck, 2002). To measure stock market liquidity several measures can be used such as: transaction cost measures; volume-based measures; price-based measures; and market-impact measures (Sarr & Lybek, 2002). This indicator can also forecast future returns because liquidity shocks have a positive correlation with shocks on the returns (Bekaert et al, 2007).
Profitability1depends both on the volatility of the market and on its liquidity. It’s
a generally accepted fact that volatility is inversely correlated with stock returns: the volatility of stocks raises after the prices of stock fall (Schwert, 1989b).
8
Using the IFC classification for defining which stock markets are emerging markets, Argentina and Brazil appear to have the highest levels of volatility with 78% and 74.4% for this markets; opposite to the U.S. 14.9% and U.K. 16.8%, being the least volatile developed markets (Goetzmann & Jorion, 1999).
The United States are regarded as the most liquid market worldwide due to the number of transactions; Chuhan (1992) quoted in Bekaert et al (2007) pointed out that the low liquidity present in some emerging markets was a disincentive for investment in these countries.
In what concerns volatility and profitability, the findings of Goetzmann and Jorion (1999) show a clear contrast between this two types of markets using IFC indices. For developed markets they found that the average dollar return was 6.9%, which corresponds to a volatility of 19.8%; on the other hand, emerging markets show an average dollar return of 9.1% and a volatility of 34.8%. Aggarwal et al, (1999) studied what kind of events could cause noticeable shifts in the volatility of emerging markets between the periods of 1985 to 1995. The conclusions show that high volatility periods are correlated
more with specific events in each country’s economy than with global events,
specifically, major political events. Two examples are the military coup in Thailand during which volatility increased from 26.7% to 55%; and one important volatile period in the United States associated with the Gulf War which registered a volatility of 22,7% between 1990 and 1991.
9
3. The Lisbon Stock Market
3.1. The Lisbon Stock Market: BVL
The period between 1870 and 1920 is regarded by some authors as the start of emerging stock markets and corresponds to the first financial globalization (Battilossi & Morys, 2011). In Portugal the year of 1769 marks the official date for the opening of the Lisbon Stock Exchange and until 1891 it was the only official stock market operating in the country (on this year on the 29th of January a Decree authorized the establishment of a stock exchange in Porto).
In what concerns the Portuguese financial sector, the creation of Banco de Lisboa by the law of 31st December 1821, the first bank to operate in Portugal, and the implementation of the first Commercial Code of 18 September 1833, are regarded as two important steps that contributed to the modernization of this sector. The stock exchange emerged as a result of State initiative and remained so during the period under analysis. The changes to the Commercial Code of 1888 regarding the administration, operation and quoting of the titles of national private companies can be seen has an incentive to stimulate this activity (Branco et al, 2015)
The BVL was a regulated and centralised market. The stock market regulations created and reinforced a structure that was hierarchical in terms of its administration and whose operations were monopolised by the brokers (Branco et al, 2015)
10
the stock exchange therefore an analysis of the Portuguese banking system and its main characteristics is important.
3.2. The Portuguese Banking System
During the first part of the 19th century the Portuguese banking system was not very developed. Due to the economic stagnation of the country coupled with the political uncertainty and the population high illiteracy rate, this sector was unable to achieve a prosperous growth. The main business of banks was to support the financing of the State. It was known that public debt was constantly under pressure and several times the Portuguese State was not able to repay the loans made, however, this was still considered an advantageous business.
On a global perspective, from the middle of the century until the beginning of the last decade, banking institutions worldwide were influenced by the consolidation of central banks; the start of a colonial banking system; and the development of investment banks mainly connected with projects that were in expansion (Valério et al, 2006).
In Portugal the contribution of the banking system to the economic development of the country improved. This was a period characterized by a certain level of banking liberty where the State depended less on the national banking system to finance itself and the banking institutions invested in different projects. Between 1850 and 1870 new commercial banks opened their doors; the first foreign banks installed affiliates that started to operate in the country and specialized banks appeared to foster the agricultural and industrial sectors (although not providing the necessary outcome) (Valério et al, 2006).
11
century) (Valério et al, 2006). The monetary circulation tripled from the beginning of the century to the beginning of the last decade and foreign trade rose. It is also noteworthy to mention the impact of the denominated era of Fontismo (between 1850 and 1880) – during which several public projects were developed and the construction of railroads, bridges and roads allowed for the modernization of the country. If on one hand there was a short term stimulus to the economy, on the other hand the attempt to finance these public investments with external debt to be repaid with the potential public revenues was a failure in the long term.
In conclusion, the banking system developed accordingly to the evolution of the
country’s economy however, it was still accessible only to a minority of the economic
agents, mainly due to the cultural backwardness present in that period.
In Portugal these following years, are marked by the polarization of the banking system by the Bank of Portugal (Valério et al, 2006). This polarization can be explained due to the abandonment of the Gold Standard regime, where the BdP was responsible for the external and internal value of the monetary unity; it become the only issuing institution operating in the country and after the partial bankruptcy of the State in 1892 this institution was once again strongly related with the financing of the State.
12
3.3. Events and Effects on the Stock Market
There were three important moments that marked the history of Portugal during the period under analysis: the banking crisis in 1876; a third generation crisis in 1891 (composed by a sovereign debt crisis; banking crisis; and a currency crisis); and the establishment of a Republic regime in Portugal in 1910.
The banking crisis of 1876 started due to the growing number of banks established in the country, which between 1873 and 1876 increased from 13 to 52, and the speculative movements around this newly created institutions (Nunes & Valério, 2005). The euphoria, during 1875, brought new products such as options, futures and warrants (Costa et al, 2010). The trigger of the crisis was the suspension of payments by some banks in the north of the country which led to the appearance of the Bank of Portugal as a last resource lender. However, even this institution had to stop operating temporarily due to its exposition to risk. The crisis led to the extinction of 1/5 of the banking institutions operating in the country (Valério et al, 2006) and by the law of 10 of April 1876 the first banking institution of the Portuguese state was created: CGD. (Nunes & Valério, 2005).
13
Gold Standard regime was abandoned on the 9th of July 1891 being adopted a
conventional monetary regime and secondly, there was a partial default being declared National Treasury bankruptcy in 1892 (Costa et al, 2010).
The last period, under this analysis, with impact on the history of capital markets in Portugal happened due to a political crisis. On the 1st of February 1908, the Portuguese King D. Carlos and his son were murdered in Lisbon. After this incident, political uncertainty lasted for two years. The end of this period was marked by the abandonment of the Constitutional Monarchy regime that lasted from the end of the Liberal Civil War in 1834 until a military coup established a Republic regime on the 5th of October 1910 (Costa et al, 2010).
4. Empirical Analysis
4.1. Definition and Sample Analysis
The objective of this study is to test several hypothesis relative to the behaviour of three financial indicators (profitability, volatility and liquidity) during the period comprehended between 1870-1913 relative to the banking sector and its performance in comparison with the General Index. During this timeline, the three indicators described before will be analysed according to the three crises that happened.
14
do Governo. A collection of data was performed for the companies that presented one of the possible quotations: Papel –Bid; Moeda –Ask; Realizado –Transaction.
The number of enterprises considered in the sample varies along the years and as observable on Table I the sectors that are present on the General Index are the following: Banking; Agriculture; Mining; Industry; Transports; Energy; and Colonies. The sector that has more companies listed during the four decades in this analysis is the banking sector which allowed the creation of a more detailed index.
In order to calculate the liquidity of the banking sector a third index was constructed. The index is composed by eleven banks that from 1870 to 1913 operated in the country: BdP; BCL; BLA; BL; BNU; CGCPP; SGAFP; BPV; BNI; CCC; CCI.
4.2. Assumptions
As stated before, the data used was originally taken from publications in Diário de Governo however, due to the lack of some information, several assumptions were made.
To construct the General Index and the Banking Sector Index the data collected considers the last quotation of the month and in each year the missing data was estimated by interpolation when possible.
For both indexes it was not possible to gather information for 1890 and the years of 1879 and 1891 only have one semester of data each.
15
Concerning the exact number of days for the calculation of liquidity, the data source were the previously referred Boletins de Cotações. When these documents exist it is assumed that the stock markets was open for transactions.
4.3. Methodology and Hypothesis Definition
Given the previous assumptions, the first step was to calculate the profitability and volatility of the quotations available. According to Hull (2012), to estimate the volatility of the quotations it is necessary to define the number of observations 𝑛 + 1; the quotations 𝑆𝑖 (with 𝑖= 1, 2… 𝑛) and obtain the profitability using:
(1) 𝑢𝑖 = ln( 𝑠𝑖
𝑠𝑖−1) where 𝑖 = 1, 2 … 𝑛
To calculate the volatility, the standard deviation of 𝑢𝑖 is given by:
(2) 𝑠 = √ 1
𝑛−1∑ (𝑢𝑛𝑖=1 𝑖− 𝑢̅)2 where 𝑢 ̅is the average of 𝑢𝑖
In order to test the correlation between volatility and profitability, the Pearson correlation coefficient was the chosen method. This method returns the correlation coefficient, 𝑟 which gives the linear relation between two sets of data.
(3) 𝑟 = ∑(𝑥−𝑥̅)(𝑦−𝑦̅)
√∑(𝑥−𝑥̅)2∑(𝑦−𝑦̅)2𝑟 ∈ [−1,1] where 𝑥 and 𝑦 are the averages of the
two sets of data
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To calculate the liquidity of the banking sector, a turnover ratio was calculated between the number of days with effective transaction over the number of possible transaction days in each year.
For this study the hypotheses that will be tested are:
Hypothesis 1) Volatility of the General and Banking Sector Index is high during and/or after critical domestic events;
Hypothesis 2) Profitability is negative in critical domestic events;
Hypothesis 3) Profitability and volatility are negatively correlated during critical events; Hypothesis 4) Liquidity of the Banking Sector Index is lower during crises;
Hypothesis 5) The international economic environment impacts in the behaviour of volatility, profitability and liquidity of the stock market:
Sub-Hypothesis 5a) During a depression and a recession period volatility is high, profitability and liquidity are low;
Sub-Hypothesis 5b) During an expansion and a recuperation period volatility is low, profitability and liquidity are high;
In order to test the different hypothesis the following methodology and tests were applied. For both indexes, in order to achieve the annual profitability, formula (1) was used. For volatility, formula (2) was applied. With the results obtained it was possible to construct two graphics (one for each index) with the profitability and volatility for each year (see Table V and VI; Figure 1 and 2). Given these graphics, a descriptive analysis is performed next.
17
variable tested. Additionally, when using the Data Analysis tool on Excel, the outputs provide the Pearson correlation coefficient and the respective P-value (necessary to check the statistical significance).
Additionally, the data used to test this hypothesis included only negative profitability of the crisis years.
To analyse the liquidity indicator the first step was to obtain the number of days with transaction in Realizado for each one of the eleven banks that compose the sample. Then, the number of days with possible transactions per year was computed allowing the calculation of the following liquidity ratio:
(4) 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑤𝑖𝑡ℎ 𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑡𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑜𝑠𝑠𝑖𝑏𝑙𝑒 𝑡𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑒𝑎𝑐ℎ 𝑦𝑒𝑎𝑟
This turnover ratio allowed the calculation of the liquidity measure by creating an interval between[0,1]. Banks that have results of 0 did not have transactions during the year and banks with results near 1 operated almost during all days on which was possible to transact.
Two simple averages were calculated with these results. The first (vertical liquidity average) gives the average liquidity for each bank individually for the period under study. The second (horizontal liquidity average) gives the annual average of liquidity from the banks that were operating on that year (see Table IX).
18
analysis the focus is towards the meaning and rhythm of the cyclical movement in relation to the tendency.Therefore, the four phasis are:
I. The real position is above the tendency and moving away from it – Phase 1 or Expansion
II. The real position is above the tendency and getting closer to it – Phase 2 or Recession
III. The real position is under the tendency and moving away from it – Phase 3 or Depression
IV. The real position is under the tendency and getting closer to it – Phase 4 or Recuperation
From the second to the third phase corresponds a situation of economic crisis. It is also noteworthy to differentiate between two types of cycles. The longer period cycles comprehend five and a half decades each and are designated by Kondratiev cycles. From the 18th century up to the end of the 20th century it is possible to identify four Kondratiev cycles, each one represented by K and its respective number.
The shorter period cycles are the Juglar cycles. These comprehend nine years between each one. Each Kondratiev cycle comprehends six Juglar cycles, each represented by J and its respective number. Table X resumes this information.
19 4.4. Results
Table II presents the results for volatility and profitability of the General Index and the Banking Sector Index for the three crises periods under analysis. In terms of volatility, the crises with biggest impact on the General Index were the Banking Crisis of 1876 and the Political Crisis of 1910. The same can be observed when looking for the Banking Sector Index – for this sector volatility was aggravated by 0.4887% in 1876 and by 0.6249% in 1910.
Concerning profitability, the crisis of 1891 was the one that affected the General Index the most with a negative profitability of 1.6931%. For the Banking Sector Index, however was during the Political Crisis of 1910 that the profits were more severely affected with a loss of 0.78%.
In order to ascertain hypothesis 1, Table V presents the results obtained for the General Index. As shown on the Figure 1, the three periods of high volatility correspond to the three periods of crisis explained before. The years of 1876; 1891 and 1910 show three well defined peaks of volatility. Under the same analysis perspective, Table VI presents the results for the banking sector. Once again three distinct peaks can be identified on Figure 2 corresponding to the three events that affected Portugal.
20
crises, a conclusion that can be taken is that stock market volatility was not the reason for these crises – it was a direct consequence of these events. From the analysis performed, hypothesis 1 is accepted.
Under the same line of analysis Table V and Table VI present the results for profitability. Using Figure 1 and 2 it is possible to visualise that both indexes show negative profitability indicators for the three distinct crises. The General Index presents higher losses of returns for the crises of 1891 and 1910. Only in 1876 the banking sector lost more profitability which can be explained due to the nature of this banking crisis. This analysis allows to accept hypothesis 2.
To test hypothesis 3 the t-Test was performed for both the General Index and the Banking Sector Index. The results are summarized on Table VII and VIII. For the General Index, the Pearson correlation coefficient has a positive value of 0.9276; for the Banking Sector Index a negative correlation of -0.9062 was obtained.
This hypothesis is confirmed only for the banking sector. The results show that there is a negative correlation between profitability/volatility pairs. Additionally, on average, this sector was more volatile during the period under study: the crisis of 1876 affected mainly the banking sector and the crisis of 1891 affected all the sectors on the stock exchange including the banking sector once again. As the P-value is less than 0.05 it is possible to say that during crises (where negative profitability is present) profitability is inversely correlated with volatility.
21
general perception that, the assets of banks were more volatile, on average, than other industries.
For the fourth hypothesis it is important to stress that in this sample not all banks operated in the country during the same periods. Table III represents a summary of their operation periods between 1871 and 1913. As referred on the assumptions, the stock market did not operate on a daily basis as today. Table IV compresses the different periodicity of data into three different measures: daily; weekly and every fortnight.
Having this information it was possible to construct table IX which uses the liquidity ratio explained in the previous section and gives the liquidity value for each bank that compose the sample. Figure 3 presents a graphical representation of the different
banks’ liquidity.
On average the most liquid bank between 1871 and 1913 was the BdP with a liquidity ratio of 0.5083 followed by the BNU: 0.3831 and BLA: 0.3497. Another important outcome of this study is that, on average, the most liquid year for the Portuguese banking sector was 1880. On the other hand, the least liquid year was 1891.
To test the hypothesis that the number of days with transactions is lower during crises, the last column in Table IX gives a highlighting view of this situation. For the Banking Crisis of 1876 the liquidity ratio dropped from 0.4615 to 0.2102 on the crisis year and continue to drop until 1878 to 0.0992.
22
The Political Crisis of 1910 affected the banking sectors’ liquidity on a different magnitude. While the 1891 crisis was the peak of a continuingly loss of liquidity, this last period was the start of the declining tendency. As explained before, the political uncertainty created lasted two years. During the following years liquidity shows a decreasing tendency. The data allowed to show that the number of operations started to decline on 1910 and continued during the next years (see Figure 3). This analysis allows to accept the fourth hypothesis.
Lastly, to test the fifth hypothesis, the data obtained was organized under the perspective of Kondratiev and Juglar cycles (see table X). Table XI resumes the averages of profitability and volatility for the General Index. Table XII resumes the averages of the three indicators for the Banking Sector Index.
To explain the logic thinking associated to this hypothesis it is important to understand that the literature defines several explanatory hypothesis for economic activity variations. According to Joseph Scumpeter the “real hypothesis” atributes the existance of economic cycles to two phenomena: technological, organizational and geographical inovations; and the change in consumer demand profiles.
23
economic cycle which can be translated into low profits; higher volatility and low liquidity. Once the iniciatives launched in expansion are liquidated, the economic cycle tends to stabilize and the fourth phasis starts: recuperation period.
To summarize it is expected that during a recession and depression periods the indicators of profitability and liquidity are low and volatility is high. On the other hand, during a recuperation and expansion periods volatility decreases and both profitability and liquidity increase. An important note to highlight is that this international conjecture is usually accepted for industrialised economies – on the sample used to construct the General Index presented on this work banks represent the vast majority of companies listed and only on the last period the industries represent a significant part of the stock exchange (see Table I).
24
25
5. Conclusions and Research Limitations
5.1. Conclusions
During the four decades studied on this work, Portugal suffered the impact of three distinct crises: a Banking Crisis in 1876; a Third Generation Crisis in 1891; and a Political Crisis in 1910. The stock exchange was composed mainly by banks and these events had repercussions over the financial sector of the country.
An important conclusion to take concerns the imunity of the LSE to external economic variations. Mainly due to the critical moments of crisis and their repercussions over the sectors represented on the stock exchange it is possible to infer that inside events in the country have a deeper impact at a financial level than external ones.
The findings regarding the three indicators studied allowed to take several conclusions. The analysis of the financial indicators allowed to find that volatility during the period under analysis was not the reason for any of the crises, but a result of them. The fact that the low liquidity present in some emerging markets is seen as a disincentive for investment can be observed on the Portuguese case. To confirm this, the collected information about the number of days with effective transaction allowed to measure the low liquidity during an identified crisis period. Rearding profitability it is an indicator that depends both on the volatility of the market and its liquidity. If on one hand the volatility is inversely correlated with stock returns it is also true that liquidity shocks have a positive correlation with shocks on the returns.
26
5.2. Research Limitations
The LSE was not as developed as others regarding the information at disposal. This research had some limitations due to the source and availability of the data collected. A setback concerns the source of the data presented due to the difficulty in obtaining values for all the years and indicators. The General Index was constructed only with information obtained from the shares of the companies that compose the sample. Additionally, the liquidity indicator was only calculated for the banking sector due to the lack of data for the General Index.
27
6. References
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the role of regional stock exchanges, 19th -20th c.
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Demirgüç-Kunt, A., & Detragiache, E. (1998, March). "The Determinants of Banking Crises in Developing and Developed Countries". IMF Staff Papers, Vol.45, No.1. Goetzmann, W., & Jorion, P. (1999, March). "Re-Emerging Markets". Journal of
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30
7. Appendix
Table I
Number of companies considered on the sample
1870s 1880s 1890s 1900s
Banking 11 11 6 6
Agriculture 1 1 1 1
Mining 1 3 0 0
Industry 1 1 2 5
Transports 1 2 1 1
Energy 1 1 1 1
Colonies 0 0 1 6
Total 16 19 12 20
Source: GHES-ISEG
Table II Indicators Variation
Crisis of 1876 Crisis of 1891 Crisis of 1910
General Index Banking Index General Index Banking Index General Index Banking Index
Profitability -0.4839% -0.5086% -1.6931% -0.2190% -0.9483% -0.7800%
Volatility 2.7815% 3.2702% 1.9636% 1.7001% 2.7743% 3.3993%
Source: Own Elaboration
Table III
Sample banks activity period Activity Period
BdP 1871-1913
BCL 1876-1913
BLA 1876-1913
BL 1871-1908
BNU 1871-1913
CGCPP 1871-1913
SGAFP 1874-1889
BPV 1876-1889
BNI 1877-1883
CCC 1876-1881
CCI 1875-1881
31 Table IV Periodicity of data
1870-1876 Weekly basis
1877-1879 Daily basis
1880-1891 Weekly basis
1892-1901 Fortnightly basis
1902-1913 Daily basis
Source: GHES-ISEG
Table V General Index Results
Year Profitability Volatility
1870 -0.1025% 1.4358%
1871 0.8241% 2.0157%
1872 0.8814% 1.8897%
1873 0.3642% 1.6938%
1874 0.5240% 1.5900%
1875 0.2471% 1.4136%
1876 -0.4839% 2.7815%
1877 -0.2844% 1.2921%
1878 -0.7154% 1.2781%
1879 -0.0294% 0.5439%
1880 0.4643% 1.2985%
1881 0.9856% 1.9685%
1882 -0.9349% 2.2167%
1883 -0.1594% 0.9434%
1884 -0.3041% 0.9557%
1885 -0.2917% 1.1450%
1886 1.0095% 2.3814%
1887 0.5369% 1.8335%
1888 0.7985% 1.7074%
1889 -0.0389% 1.3997%
1890 n.d n.d.
1891 -1.6931% 1.9636%
Year Profitability Volatility
1892 0.0853% 2.2812%
1893 -0.5798% 4.5408%
1894 1.2130% 2.1158%
1895 1.1194% 2.0061%
1896 0.5481% 1.8737%
1897 0.2261% 3.1108%
1898 0.2815% 2.5620%
1899 0.6277% 3.2657%
1900 0.2175% 2.7546%
1901 -0.3484% 1.2636%
1902 0.4534% 2.5047%
1903 0.1759% 1.7947%
1904 0.1777% 2.3079%
1905 -0.0251% 1.6628%
1906 -0.1657% 0.7376%
1907 -0.6353% 1.5305%
1908 -0.2725% 1.9561%
1909 0.6365% 2.1005%
1910 -0.9483% 2.7743%
1911 -0.2648% 1.5497%
1912 -0.1036% 1.3480%
32 Table VI
Banking Sector Index Results
Years Profitability Volatility
1870 -0.1516% 1.5870%
1871 0.7782% 1.8432%
1872 0.8021% 1.5625%
1873 0.3293% 1.5408%
1874 0.4345% 1.3143%
1875 0.2698% 1.6289%
1876 -0.5086% 3.2702%
1877 -0.3557% 1.6386%
1878 -0.7942% 1.3061%
1879 0.4795% 1.3844%
1880 0.6296% 1.3569%
1881 1.0311% 1.7973%
1882 -0.8427% 2.1150%
1883 -0.1110% 1.0967%
1884 -0.3041% 0.9347%
1885 -0.4446% 1.4282%
1886 0.6231% 1.8766%
1887 0.8667% 2.2657%
1888 0.6925% 2.6118%
1889 0.1087% 1.4050%
1890 n.d. n.d.
1891 -0.2190% 1.7001%
Years Profitability Volatility
1892 0.0838% 2.4479%
1893 0.0019% 5.4060%
1894 0.9347% 1.1183%
1895 0.2109% 1.8769%
1896 0.6021% 3.0663%
1897 -0.0709% 2.0637%
1898 0.1416% 2.1467%
1899 0.4392% 0.6529%
1900 0.5569% 1.9019%
1901 0.2961% 1.0598%
1902 0.3172% 0.8470%
1903 0.1500% 1.3590%
1904 0.0424% 1.5809%
1905 0.0251% 1.8772%
1906 -0.1247% 0.8326%
1907 -0.1639% 0.7322%
1908 -0.2397% 1.5388%
1909 0.3421% 1.5787%
1910 -0.7800% 3.3993%
1911 -0.5739% 1.7434%
1912 0.2637% 1.6490%
33
Figure 1 – General Index Results
Source: Own Elaboration
Figure 2 – Banking Sector Index Results
Source: Own Elaboration
-3,0000% -2,0000% -1,0000% 0,0000% 1,0000% 2,0000% 3,0000% 4,0000% 5,0000%
General Index Results
Profitability Volatility
-2,0000% -1,0000% 0,0000% 1,0000% 2,0000% 3,0000% 4,0000% 5,0000% 6,0000%
Banking Sector Index Results
34 Table VII
General Index: t-Test results for Crisis Years
t-Test: Paired Two Sample for Means
Profitability Volatility
Mean -0,010417861 0,025064704
Variance 3,72076E-05 2,21061E-05
Observations 3 3
Pearson Correlation 0,927589589
Hypothesized Mean Difference 0
Df 2
t Stat -24,86704667
P(T<=t) one-tail 0,000806621
t cCritical one-tail 2,91998558
P(T<=t) two-tail 0,001613243
t Critical two-tail 4,30265273
Source: Own Elaboration
Table VIII
Banking Sector Index: t-Test results for Crisis Years
t-Test: Paired Two Sample for Means
Profitability Volatility
Mean -0,005025008 0,027898715
Variance 7,8716E-06 8,94829E-05
Observations 3 3
Pearson Correlation -0,90616336
Hypothesized Mean Difference 0
df 2
t Stat -4,728324013
P(T<=t) one-tail 0,020967579
t cCritical one-tail 2,91998558
P(T<=t) two-tail 0,041935157
t Critical two-tail 4,30265273
35
Ta
ble
IX
B
ankin
g
S
ec
tor
Inde
x
L
iquidi
ty
R
esult
36
S
o
u
rce
:
GHE
S
-I
SEG
an
d
o
w
n
elab
o
ratio
n
38 Table X
Kondratiev and Juglar Cycles
Kondratiev cycle –
K2
Period above the
tendency
Expansion 1843 – 52 K2J1
Recession
1852 - 61 K2J2
1861 – 70 K2J3
1870 – 72 K2J4
Depression Point Economic Crisis 1873 K2J4
Period under the
tendency
Depression
1874 - 79 K2J4
1879 - 88 K2J5
Recuperation 1888 - 97 K2J6
Kondratiev cycle –
K3
Period above the
tendency
Expansion 1897 – 06 K3J1
1906 - 14 K3J2
Source: Own Elaboration
Table XI
General Index Results and Kondratiev/Juglar Cycles
Years Kondratiev and
Juglar cycles
Relation to
tendency Period type Profitability Volatility
1870-1879 K2J4 Above Recession 0,1394% 1,7100%
1879-1888 K2J5 Under Depression 0,1418% 1,4763%
1888-1897 K2J6 Under Recuperation 0,1816% 2,2360%
1897-1906 K3J1 Above Expansion 0,1985% 2,3585%
1906-1914 K3J2 Above Expansion -0,2231% 1,5979%
39 Table XII
Banking Sector Index Results and Kondratiev/Juglar Cycles
Years
Kondratiev and Juglar
cycles
Relation to
tendency Period type Profitability Volatility Liquidity
1870-1879 K2J4 Above Recession 0,1283% 1,7435% 0,2794
1879-1888 K2J5 Under Depression 0,2142% 1,5840% 0,2452
1888-1897 K2J6 Under Recuperation 0,3020% 2,4540% 0,2289
1897-1906 K3J1 Above Expansion 0,2109% 1,4988% 0,3395
1906-1914 K3J2 Above Expansion -0,1143% 1,5649% 0,2552
Source: Own Elaboration
