Indonesia's stock market: evolving role, growing efficiency

Abstract

The banking sector traditionally dominated Indonesia's financial system, and until the 1990s the stock market remained of little significance. Re-opened in 1977 after two decades of inactivity, the stock exchange made little contribution to Indonesia's development until a series of reform and deregulation measures were implemented from December 1987. This study examines the evolving role of the stock market in the financial system, and analyses changes in its efficiency over time. We find that stock market activity grew markedly in importance relative to banking after the reforms began to take effect, gaining the ascendancy in 2004 and moving well ahead subsequently. One contributor to this success is improvement in efficiency. Using two simple technical trading rules, we demonstrate that the stock exchange secondary market has indeed become significantly more efficient over time.

Notes

¹The present study focuses on Indonesia's stock market; for the bond market, see World Bank (2006).

²Other channels include trade credit, supplier credit and direct (non-intermediated) loans and equity finance.

³This ended two decades of inactivity, beginning in the 1950s under former President Soekarno (http://www.idx.co.id/). For an account of the Jakarta Stock Exchange in the early 1980s, see McLeod (1984).

⁴For detailed discussions of stock market developments in the late 1980s and early 1990s, see Noerhadi (1994) and Cole and Slade (1996).

⁵Many studies indicate that automation helps improve stock market efficiency; see, for example, Amihud and Mendelson (1988) and Naidu and Rozeff (1994).

⁶According to this source, more than 50% of 2000 GDP was spent on recapitalising Indonesian banks; see also Frécaut (2004).

⁷See, for example, De Brouwer (1999) and Wang (2004). In principle, integration can enhance market liquidity and exert competitive pressure on individual markets, thus reducing transaction costs and increasing the incentives for innovation.

⁸Derivative and spot markets are closely linked. Because derivative markets are very effective at re-allocating risk, more investors are willing to invest in the underlying assets (such as stocks) and, as a result, more companies are able to raise needed capital.

⁹For example, Brock, Lakonishok and LeBaron (1992), Bessembinder and Chan (1998) and Siegel (2002) all used a 1% band for their technical rules.

¹⁰In practice, there is no such thing as literally investing in a market index. However, an index fund can be used as a proxy for the market index. An index fund is a mutual fund that holds shares in proportion to their representation in a market index.

¹¹In addition to a holding period of 5 days, we also used holding periods of 10 and 20 days. The results are not reported here, but are similar to those for 5 days.

¹²A two-tailed test is not used because it is not relevant, for either buys or sells, to test an alternative hypothesis stating that the mean j-day return is less than the unconditional mean j-day return.