What explains the recent expansion in the scale of the equities market?

1. Introduction

The equities market has seen expansive growth in Europe as well as many emerging economises since 1990. Its presence in the global market continues to outperform the growth of banking and capital markets, and is largely seen as a reliable investment alternative that is favoured over low bank interest rate returns or sluggish return on government bonds. To add to this, economists and the driving factors of the demand for equity markets have developed intelligent systems such as BETA and CAPM to find a suitable trade-off between risk and return as a means of profit maximisation.

1.1 Data

As a percentage of GDP, the UK investment in equities markets was 0.9% in 2004 Its overall annual return since 1900 has been averaging 1.8% in the UK, but has seen substantially higher returns in recent years.

2. Who is exercising Demand?

Whilst investment in the equities market is often a risk loving adventure, analysts have highlighted that it has in fact become a relatively low risk market in comparison with other markets and the rewards are frequently substantial. With the slowdown of the commercial and domestic property market, the sluggish government bond yields and near all-time low interest rates, investors are being forced to turn to the equities market for higher rewards. To parallel this, the equities market in the UK, Europe, USA and recently Japan have grown consistently, the S&P 500 reporting gains of 20% by the second quarter of last year. Reuters estimates the UK equity market to reap returns of 8.8% in 2005 after an even more successful year in 2004 which saw returns of 16.0%. This compares to the an interest rate of 4.5% and bond returns at 3.4%. Clearly, the demand for the equities market is exercised by investors seeking an alternative to the low returns in property investment, banking or bond markets and are being encouraged by the reliability and fast-track recovery of equity markets worldwide.

In conjunction with the noticeable reasons for the demand of equity markets, Sloman suggests that the efficient (capital) market hypothesis is also a factor of exercising demand. Demand in equity markets, he argues is exercised by the availability of accurate information which could spark widespread demand if the actual dividends is less that expected dividends or if the information relating to the growth of a particular business or market shows low risk gains. A rational investor will evaluate the form of efficiency illustrated by the markets and the information gained from the markets will exercise an increase in demand. A semi-strong form of efficiency on the other hand, will involve a higher form of risk taking whereby demand would be relatively stable, but low.

It is apparent that the efficiency of the equity markets in terms of the information made available is pointing to stability and an relatively high gains. These pointers are encouraging investors and demand

3. What is driving the demand?

Although private investment in the equities markets accounts for approximately 6% of the market, the majority of the market is comprised of institutional investors, pension funds, insurance funds and mutual funds. When MR

3.1 Institutional Investors

The demand trend for institutional investors to invest in equity markets continues to rise. Their demand has largely been based on the transparency of the markets, access to historical and expected returns information, as well as its favourability over other markets in times of economic uncertainty. The last factor is widely highlighted as the most congruent amongst international equity markets, especially in the US.

3.2 Pension Funds

Pension funds are often known to take an aggressive investment approach in the equities markets in hopes of gaining substantial rewards. Recently the demand for access to equity markets has been fuelled by greater reliability and relatively low-risk investment in the equities market whilst other markets remain uncertain and unstable. Interestingly, pension fund investments currently account for 22% of the equities market in Europe and are expected to grow as the market continues to encourage long-term investors.

3.3 Insurance Funds

In conjunction with pension funds, insurance funds are increasingly favouring the long-term return of investing in equity markets.

3.4 Mutual Funds

The federal reserve findings on mutual fund investment in the equities market found that internet availability and lowered transaction costs have led to an environment that is more attractive for mutual fund investors. It would appear that the UK has a similar environment encouraging a similar increase in demand. Mutual funds or unit trusts have driven demand as a result of greater access via the internet and greater market awareness. Lipseyalso claims that its demand has derived from small investors that are able to access foreign markets via mutual funds which would otherwise face bureaucracy and restrictions. Arguably, the portfolio based mutual funds are just as attractive to large firms as they are able to minimise risk by accessing a number of markets on behalf of professional investors. i.e. an FSA regulated institution that is bound to give adequate advice.

4. Shift from Banking Markets in 1970’s to Capital Markets

Following the collapse of the Benton Woods System in the early 1970’s, the banking market had become volatile and unstable in the western world. Capital markets on the other hand were profitable alternatives, which with the increases in technology meant that more of it was demanded as well as supplied. The quantity of Capital (C) demanded by a firm or individual depends on the marginal revenue (MR) product of capital and the interest rate. The demand for capital increased steadily when expectations about the future of MR were high. Parkin claims that the move from banking markets were based on two primary reasons: 1.) Population growth; and 2) technological change. Quite simply an increase in population growth that correlates to an increase in technological change will inherently lead to a demand for capital markets.

Arguably another shift in demand for capital markets is the collapse of the Soviet Union which liberalised markets in eastern Europe and the former USSR. This has also contributed to the globalisation of world markets.


Axa Private Equity Statistics, Axa Private Equity Statistics, http://www.axaprivateequity.com/index.cfm?pagepath=EspacePresse&CFNoCache=TRUE&servedoc=FE1BD146-B949-9057-2A3C5837B4570F7D

Source: ChinaStones - http://china-stones.info/free-essays/economics/equities-market-essay.php

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