THE RISK FACTORS ASSOCIATED WITH INVESTING IN AN EMERGING EQUITY MARKET DURING THE EU MEMBERSHIP PROCESS

This paper identifies the risks associated with investing in the Turkish stock market. We find that Turkish firms are more volatile than firms in countries that have recently joined the EU (our control group) and that the excess volatility is significantly associated with higher financial and economic risks rather than fundamentals. Additionally, firms’ fundamentals are as important as country risk factors in explaining stock risk premiums for the control group, while the combined effect of country risk scores has a greater impact on risk premiums than firms’ fundamentals alone for Turkish firms. Also, while Turkish stocks are sensitive to all country risk factors — economic conditions, international openness, investment profile, conflicts, and social tensions — stocks of the control group are mostly affected by only two factors, namely social tensions and economic conditions. Finally, some risks have become less relevant as a result of the changes in legal, political, and economic policies that occurred from 1999 to 2004 (the candidacy period for EU membership). Overall, Turkey has been quite successful at pursuing reforms since it began its candidacy for the EU. It has liberalized its political system and relaxed restrictions on freedom. It has also reduced hyperinflation, strengthened its currency, lowered interest rates, and provided more stable growth in GDP. However, political stability and financial and economic development appear to be issues for Turkey in its quest to become an EU member.