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Rose W. Ngugi, Victor Murinde and Christopher J. Green 1. INTRODUCTION Since the early 1990s, many developing countries have launched new stock markets or revitalized existing ones in order to enhance the development of capital markets and facilitate access to long-term capital. Emerging stock markets (ESMs)1 now exist in about 70 developing countries. Although the ESMs faced a declining trend after the Asian financial crisis, they almost outperformed their developed counterparts. In 1999, the ESMs took 30 per cent of the top 20 positions, ranked by market capitalization. The market liquidity of the ESMs increased phenomenally while most emerging market indices went up, partly reflecting growing demand in share trading (see Kim and Singal, 2000). The revitalization of ESMs has involved institutional and policy reforms aimed at improving stock market performance by reducing costs of trading and volatility as well as increasing market liquidity and efficiency. The main institutional and policy reforms include adoption of new trading systems, relaxation of foreign investment restrictions, expansion of stock market membership, strengthening of the legal and regulatory frameworks and reform of taxation policy. See, for example, Röell (1992), Khambata (2000) and Kawakatsu and Morey (1999). It may be argued that there is a link between revitalization of ESMs, improved market microstructure and economic development. Precisely, the argument is that, if it has an efficient price discovery process, no excess volatility and provides liquidity at low costs, the stock market can make important contribution to the development process. The...