Question

what is the impact of financial market linkages?

their impact on stock exchange and other financial institution and their role as whole.

i need details please because i dont know what a financial market linkage is

thank you

Answer 1

Financial Linkage is the ability to buy a security on one financial exchange and sell that same security on another exchange. Certain depositary receipts, such as American Depositary Receipts (ADRs) allow for linkage, which means that an investor can purchase shares of a company on a foreign exchange, such as the Toronto Stock Exchange, and then sell those shares on a domestic exchange, such as the New York Stock Exchange. ADRs allow investors around the world to buy and sell large international companies' stock. Because a security’s price may be different on various exchanges, an investor might profit by selling the stock for a higher price than for which he bought it, thus creating an arbitrage opportunities.

How financial linkages have impacted the stock exchange and financial institutions:

It is generally accepted that the major world stock markets have become more closely linked in recent years. A range of factors can be identified that have strengthened the markets linkages stock in different parts of the world, including:

• The increasing importance of international capital flows and mobility, resulting from the progressive removal of controls on capital movements by the major industrialized countries and some developing countries. This is especially the case since the move from a fixed to a flexible exchange rate system among major world currencies in 1973.

• A general world-wide move to deregulate financial markets. The reduction of the degree of government intervention allows freely floating (market determined) prices and quantities to transmit excess demand pressures to other related markets.

• Technological advances. These have improved the speed of international financial transactions, improved the international flow of information between markets, helped to reduce transactions costs and led to effective 24-hour trading.

• Increases in the number of multinational companies whose shares are cross-listed on more than one major international stock exchange. Such companies also tend to be involved in economic activities in a number of different countries around the world and hence their performance will increasingly tend to be affected by global rather than country-specific factors.

• Increasing international trade.

Although these trends have had an impact on a range of different financial markets, it is in markets at globalization has proceeded most rapidly.

One impact of increased linkages among stock markets internationally is that price movements and other shocks are likely to be transmitted more rapidly between markets;increased interdependence between markets leads to a more rapid and larger transmission of national financial disturbances—through “contagion” effects—to other markets More specifically, a price fall in one market may lead to falls in other major markets—as apparently illustrated by the October 1987 collapse of equity prices world-wide, and on a smaller scale by the impact of the Mexican market crash in January 1995 on other markets in Latin America. More recently, in 1997, major disturbances in both currency and stock markets in East Asia appeared to be transmitted rapidly around the region, and subsequently had an impact on major developed country stock markets. These developments are of particular concern if market movements are excessive in relation to changes in economic fundamentals, in that the impact on other markets may be unnecessarily and undesirably disruptive, distorting the allocation of financial capital within an economy.

A second impact of increased stock market linkages results from changes in the co-movements between prices in different markets, which can have a major impact on international portfolio diversification. As is well known from standard portfolio diversification theory, if the returns on assets in a portfolio have a correlation of less than unity, then diversification can reduce risk. In the extreme case, where the returns are perfectly negatively correlated, then diversification can in theory eliminate risk entirely.

Grubel (1968) gave one of the earliest expositions of how these benefits could be extended by diversifying a portfolio internationally, and in recent years international portfolio diversification has become fashionable because of the belief that the returns on financials assets from different countries had relatively low correlations; indeed, “the main driving force in [global equity] markets has been the fact that international portfolio diversification lowers risks without sacrificing expected returns” . If international stock market integration leads to changes in the correlations of price changes between those markets, or alters the stability of correlations between markets,1 then there are implications for international diversification and for portfolio capital flows between countries. The amount of benefit from international portfolio diversification is different under segmented markets than under internationally linked markets

If stronger linkages lead to greater co-movements between markets internationally, the benefits of diversification may be reduced and hence there may be a reduction in portfolio investment flows.

2 As von Furstenburg and Jeon (1989: 163) have noted: “the spectacle of nearly simultaneous price collapses around the world in the [1987] crash should have to revise their views about how much diversification gain could really be reaped from investing in different national stock markets.

ROLE OF FINANCIAL MARKET LINKAGES

Linkage can mean buying a security on one exchange and selling it on another exchange. (Note, however, that linkage is different from the concept of a dual listing on two exchanges.) Often, when investors engage in linkage, as we mean it here, they are in fact seeking an arbitrage situation—profiting from the same stock’s price differential on different exchanges. Arbitrage generally promotes healthy competition among the various exchanges, and this type of linkage has become easier with the advent of electronic exchanges and trading platforms.

Two other examples of this type of linkage come to mind. The first is in the Bitcoin (BTC) economy, where arbitrage serves an important function. In BTC trading, individual traders, as well as automated bots, actively scan for price differences between the various Bitcoin exchanges, then buy from one and sell to another exchange if the price disparity ever becomes high enough for the transaction to be profitable.

The second example occurs in the microfinance space. Here, “linkages” between established (or formal) financial services institutions and less formal (or informal) financial systems combine to provide financial help to the poor. Formal financial institutions have extensive infrastructures, systems, and access to funds; they are usually far removed from rural or poor clients, which makes it difficult to obtain adequate information and reduce risks. In contrast, informal financial institutions operate close to rural clients, possess quite good information and enforcement abilities; and typically are more flexible and innovative than formal institutions. The strengths of one compliment the weaknesses of the other, which enables the linked institutions to offer millions of very poor people the opportunity to receive and repay small loans, even though they possess few actual assets or skills.