Classification of Capital Markets by Using Cluster Analysis

Abstract

Financial markets have become pivotal segments of an economy over the past three decades. Because
they act as the facilitators between the investors and the industries by serving the dual purposes of
channelizing the funds to the industries and fetching higher returns to the investors. However, many
investors hesitate to invest their surplus funds in capital markets because of the dynamic nature and the
inherent risk and uncertainty of the capital markets. The investors always aim to minimize the risk and
maximize the returns by constructing optimum portfolio. After globalization, almost all the economies
have liberalized their capital markets allowing the foreign investors to invest. In these circumstances, the
investors can tap the opportunities that exist in different capital markets around the world. However,
investing in randomly selected capital markets result in huge losses. So, one of the best ways to choose
the markets is to look for the similarity in the characteristics of the markets, classify them into different
categories, and select to invest in these markets. There are some international agencies such as
International Monetary Fund, Dow Jones, Financial Times Stock Exchange, and Morgan Stanley Capital
International, which classified the markets into different categories as developed, emerging and frontier
markets by using some financial and socio-economic variables, however, this kind of classification cannot
be verified by the investors since it is very complex to obtain the data for these variables. Also, there are
very few studies, concerning the classification of capital markets based on financial variables. Therefore,
we tried to classify the capital markets into different categories in much simple manner by using financial
variables, which are available in open sources. We considered 60 capital markets around the world and
employed clustering techniques to classify these capital markets as highly developed, advanced emerging,
secondary emerging and frontier markets.