(January 11, 2013) — During volatile economic climates, herding behavior among investors is a reality in oil-rich frontier stock markets of Abu Dubai, Dubai, Kuwait, Qatar and Saudi Arabia, a newly released academic paper shows.
The paper hones in on the markets of the Gulf Cooperation Council (GCC)– the political and economic union of the Arab states bordering the Persian Gulf.
“Diversification benefits in Gulf area markets for global investors are numerous,” co-author Riza Demirer, a professor at Southern Illinois University, tells aiCIO. He adds, however, that investors’ hands are often tied from harnessing these typically secretive and closed-off markets. “The Gulf area is trying to upgrade from frontier to emerging market status, and when that happens, they will be more often to foreign investors.”
He adds: “Gulf area market stocks will always benefit from high oil prices, and with oil prices continuing to be volatile, investors can harness opportunities in the region.”
Thus, in anticipation of that, according to the research, global investors should be aware of the potential of the area.
As outlined by the paper, GCC frontier stock markets respond significantly to global market conditions in two distinct ways:
(1) global factors play a significant role in determining various economic cycles in these frontier markets as well as their transitions from one cycle to another
(2) shocks in global systematic risk factors significantly contribute to investor herding in these frontier markets.
“Higher levels of global risk indexes including the VIX and the FSI as well as positive changes in the US stock market performance and in the price of oil govern the transitions out of low into higher volatility states during which herding behavior is found to be present,” the paper asserts.
Additionally, the paper notes that these findings imply that equity investment, particularly in Dubai and Kuwait. Policy makers in these two markets should be cognizant of the findings, and thereby build safety circuits and hedging instruments to deal with volatility. “It will be a remiss if we do not point out that the volatility in Abu Dhabi is anti-persistent even in the low volatility environment. This speaks out for the different type of spending and economic growth policies pursued in this oil-rich emirate, which has the second largest sovereign wealth fund in the world. It is safe to say that the Abu Dhabi market is for the risk-averse and faint-hearted investors,” the authors write.