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Interest in the Latin American emerging markets (LAEM) has increased considerably in recent years. However, in their stock markets the price determination process and how it compares with that of developed markets is still an open issue. Thus far, the LAEM and most of the emerging markets may have, as it is often claimed, paid a price for being too different, that is, for having weak institutions, failed macroeconomic programs, political instability, poor corporate governance, and high trading costs. Although they may have indeed suffered for these reasons, this claim ignores the heterogeneity that exists among emerging markets regarding their market development and institutional infrastructure (Yilmaz (2001)). Practitioners still think that the LAEM may lower an international investor’s unconditional portfolio risk. In view of this belief concerning emerging markets, the present thesis seeks to answer three sets of questions: (1) What are the investment laws in the LAEM and how do they compare to developed countries? (2) How heterogeneous are the implicit trading costs in the LAEM and which factors are responsible for the heterogeneity? And how different is the implicit trading cost of the LAEM from the developed stock markets? And (3) does the predictability of stock returns in the LAEM differ from those documented for developed markets?

This chapter presents Latin American emerging markets. Here we shall discuss two questions that are important to investors: (1) What are the financial, economic, and political characteristics of Latin America? And (2) what are the investment laws there? To answer the first question, the political, economic, financial, and compound risk indexes of the International Country Risk Guide (ICRG) are used. As regards investor regulation, on the other hand, shareholder rights, their enforcement, insider trading, and the barriers imposed on foreign investors are first discussed. Thus, to answer the second question, it is necessary to construct an Investment Law Index by which the relevant information is aggregated.

Before participating in a stock market, investors compare it with other stock markets. For the comparison, three factors are often mentioned in the literature: stock returns, their associated risk, and the cost of trading. The present chapter concentrates on the influence of the development state and trading architecture on the trading costs in the LAEM. The design of indexes has proved to be an efficient way to make comparisons between stock markets (Demirgüc-Kunt and Levine (1996), Erb, Harvey, and Viskanta (1996)). By means of indexes, it is possible to answer three questions: (1) How heterogeneous are the implicit trading costs in the LAEM? (2) How different are the implicit trading costs of the LAEM from the developed markets? And of considerable importance: (3) Which factors are responsible for the differences? To answer these questions is the chief aim of this chapter. To do so, two main indexes are constructed here: the DS-Index and the TA-Index. Because they determine the implicit costs, the focus in what follows will be on the development state and the trading architecture.

In contrast to the large number of investigations on asset pricing behavior of U.S. and other developed markets, there are few publications about Latin American stock markets. Moreover, the published papers, which test for “anomalies” at a stock level in the Latin American markets, show contradictory results. For this reason and in order to reconcile the results, one question is investigated in this chapter: Are there -, -, -, and -effects in the LAEM for different sample periods, with different grouping procedures, and different return estimation?

The principal aim of the present chapter is to explore the predictability of equity returns in Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. We study the joint roles of market returns ( −) or and firm size, price-to-book value, price-to-earnings, and turnover. Since the robustness of the results is important, the two most discussed econometric methodologies of the cross-sectional behavior of stock returns are employed: (1) the time series regression approach developed by Black et al. (1972) and (2) the cross-sectional approach of Fama and MacBeth (1973).

Before participating in a stock market, investors compare it with others. In the literature three factors are often considered important for the comparison: stock returns, their associated risk, and cost of trading. Accordingly, in the forgoing we have studied three questions with regard to the seven major Latin American stock markets: (1) How different are the financial, economic, and political conditions of the LAEM from the developed markets and what are the investment laws in the LAEM? (2) What is the cost of trading in the LAEM; is it higher than in the developed stock markets? And (3) does the return determination process in the LAEM differ from those processes documented for the developed markets? The first and second questions were studied in the first part of this thesis (Chapters 2 and 3), while the third question was addressed in the second part (Chapters 4 and 5).