THE UNIVERSITY OF HULL Bursa Malaysia Index Series Revision Effects on Market Microstructure being a thesis submitted for the Degree of Doctor of Philosophy (Finance) in the University of Hull by Mohamad Nazri Bin Abd Karim Bachelor of Economics, International Islamic University Malaysia (1999) Master of Science (Finance), International Islamic University Malaysia (2004) August 2016 Acknowledgements First of all, I am thankful to Allah, the Most Wisdom, for His blessings and bounties to give me this opportunity to pursue and complete my PhD. Without His will, this work would not have been accomplished. With His blessings, all things are possible. I am deeply thankful to my supervisor Dr. Alcino Azevedo for his continuous supervision, support and encouragement, not only in his capacity as my first supervisor, but as a mentor. I deeply appreciate his academic leadership, intellectual rigour, constructive criticisms, advice and intellectual contribution. Without his tremendous assistance and guidance this thesis would not have been completed. My thanks also go to Dr. Mark Rhodes for his valuable support and contribution as my second supervisor during my first year. Not to forget my gratitude also goes to Professor Andros Gregoriou for his countless assistance, ideas, and constructive comments in developing this thesis. I am also grateful to the staff (academic and non-academic) of Accounting and Finance, Hull Business School the University of Hull, for their academic and administrative supports. Millions thanks also due to my family, especially my parents, Fuziah Mohammad and Abd Karim Ibrahim, my brothers and sisters for their support, encouragement and continuous prayers. Not forgetting my beloved wife, Amal Hayati Ahmad Khair, my sons, Naaeil, Eehab, and Zade, and my daughter, Walaa’ for their understanding, eternal love, unfailing moral support and continuous prayers throughout this long journey without which this work would have been impossible. Alhamdulillah. i Declaration Part of chapters three and four is published in Journal of International Financial Markets and Money, 28 (2014) 20– 35 (Joint with Alcino Azevedo, Andros Gregoriou and Mark Rhodes). Conference Presentation: Chapter 3 was presented at the International Conference on Applied Financial Economics AFE June 2012, Samos, Greece and Seminar Centre for Empirical Finance and Banking (CEFB) University of Hull 2012. Chapter 4 was presented at the 5th PhD experience Conference at the University of Hull, April, 2014. Chapter 5 was presented at the Accounting & Finance PhD Seminar, University of Hull, November, 2014. ii Abstract This thesis presents three interrelated empirical chapters on the Bursa Malaysia index series revisions effects on market microstructure. In the first empirical chapter, “The Effect of Changes in the Composition of the FTSE Bursa Malaysia Indices on Stock Price and Volume", the effect of re-constituents of the main indices (Big Cap, Mid Cap and Small Cap) on stock price and trade volume is investigated, using a data sample which comprises information dated from the time period between 2005 and 2012. An event- study methodology is employed to evaluate the effects of stock market reactions to extraneous event. I employ short term and long term event-window analysis for abnormal returns using cumulative abnormal return (CAR) and Buy and Hold Abnormal Return (BHAR). Harris and Gurel (1986) Volume Ratio (VR) methodology is used to test for abnormal trade volume. The results provide new empirical evidence supporting several hypotheses as previously studied in the literature. Empirical evidence supporting the Price Pressure Hypotheses (PPH) is found for both additions to and deletions from the Blue Chip Index, KLCI 30. There are positive abnormal returns for stocks added to the Mid Cap Index, KLCI 70 with a persistent increase in volume in the post event-window are observed, which supports the Information Cost Liquidity Hypotheses (ICLH) and results for the deletions support the Information Hypotheses (IH). The results support the Imperfect Substitute Hypotheses in the case of stocks added to the Small Cap index. The second empirical chapter studies “The Effect of the FTSE Bursa Malaysia Index Series Changes on Stocks Liquidity”. In this chapter, the effect of index revision on stock liquidity is investigated. This investigation is important particularly with regard to stocks added to the Mid Cap Index in order to assert my previous results regarding the ICLH as some researchers consider trade volume as an unsuitable liquidity proxy due to the double counting. Instead, a variety of liquidity measures are employed to capture multi-dimensional liquidity aspects. Specifically the study focuses on trading cost and price impact ratio as two different liquidity dimensions. Liquidity changes adapting Hedge and McDermott’s (2003) methodology is used; a pooled time series cross-sectional iii multivariate analysis of bid-ask spreads and also price impact ratios. Bid-ask spread (quoted), bid-ask spread (effective), Amihud’s (2002) RtoV, Florackis et al.’s (2011) RtoTR and a new price impact ratio, the RtoTRF (free float adjusted) are employed. The study is extended by examining the investability weight change in order to identify the type of shareholders that contribute more to the liquidity improvement. Evidence that supports the ICLH for stocks added to the KLCI 70 is found which confirms the earlier investigation using trade volume. More importantly, the finding support Florackis et al.’s (2011) argument on the advantages of their price impact ratio over Amihud’s (2002) liquidity ratio in terms of market capitalisation bias. Furthermore, the new liquidity measure, RtoTRF, prove to have better “encapsulation power” (at least for the Malaysian stock market) when compare to the Amihud’s (2002) liquidity measure, RtoV. The third empirical chapter investigates the effect of liquidity improvements on investment opportunities, entitled: “Does Liquidity Increase Investment Opportunity? Evidence from the Bursa Malaysia KLCI 70”. In this chapter, the relationship between improved stock liquidity and investment opportunity is investigated in light of the firms added to the Mid Cap Index. The liquidity premium hypotheses (LPH) is examined by testing whether investment opportunities increase with stock liquidity. Tobin’s Q, capital expenditures, Return on Assets (ROA) and Price Earnings (PE) ratio are used for growth opportunities and find a statistical significant increase in those depended variables after the stocks being added to the index. Amihud’s (2002) RtoV, Florackis et al.’s (2011) RtoTR and the RtoTRF ratios are proxied as liquidity measures and find that the firms whose stocks were added to the KLCI 70 had a significant increase in capital expenditures and PE ratio. The findings are consistent with those of Becker-Blease and Paul (2006). Therefore, it shows that the stock liquidity improvements associated with additions to the KLCI 70 affects firm’s investment decisions. For the LPH, it shows that investors demand lower returns on more liquid stocks and, which reduces the cost of capital and enhances growth opportunities. iv Table of Contents Acknowledgements .......................................................................................................... i Declaration ...................................................................................................................... ii Abstract .......................................................................................................................... iii List of Tables ................................................................................................................. xii List of Figures .............................................................................................................. xiv List of Abbreviations .....................................................................................................xv Chapter 1: Introduction ..................................................................................................1 1.1 Introduction ........................................................................................................ 1 1.2 Motivation .......................................................................................................... 2 1.3 Research Questions ............................................................................................ 7 1.4 Contributions ..................................................................................................... 9 1.5 Overview and structure of the thesis ................................................................ 13 Chapter 2: Malaysian Equity Market and Bursa Malaysia Index Restructuring ..15 2.1 Introduction ...................................................................................................... 15 2.2 The Exchange: Bursa Malaysia ....................................................................... 17 2.3 Bursa Malaysia Partnership with FTSE ........................................................... 19 v 2.4 FTSE Bursa Malaysia Indices .......................................................................... 20 2.4.1 FTSE Bursa Malaysia Index Family ........................................................ 21 2.4.1.1 FTSE Bursa Malaysia KLCI 30 ........................................................................... 25 2.4.1.2 FTSE Bursa Malaysia KLCI 70 ..........................................................................