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Equity premium in Finland and long-term performance of the Finnish equity and money markets

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Abstract

Using new monthly series collected together for the first time for Finland, this paper analyses the performance and development of the Finnish equity and money markets as well as the equity premium and inflation from 1912 to 2009. The series are analyzed and compared to similar series from Sweden and USA. Continuously compounded nominal returns in Finland have been high, 12.91 and 6.44 % per annum for the stock and money markets, respectively. However, taking into account the high annual average inflation rate of 7.77, the Finnish market has provided clearly lower real returns than the US market. On the other hand, the equity premium, 10.14 % per annum, is found to be comparable to that of the United States (9.35 %) and higher than that in Sweden (6.01 %) using an approach similar to Mehra and Prescott (Handbook of the economics of finance, vol 1B. Financial Markets and Asset Pricing, North Holland, 2003). Finally, our empirical evidence suggests that as the Finnish stock market has matured, it shows an increasing degree of informational efficiency while at the same time becoming more intertwined with international markets.

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Notes

  1. One has to remember that Finland was part of Russian Empire until 1917. The first exchange in Russia was established in St. Petersburg already in the eighteenth century. Trading in stocks started later, in the 1830s (see Borodkin and Perelman 2011). Shares of some Finnish companies were traded there occasionally. The first stock exchange in Finland was opened in Helsinki in November 1862 by a local stock exchange association. The association was discontinued in 1869, but a new association was set up to continue its operations. Even though there was interest among the public, the trading activity remained relatively low and the exchange lacked proper organization and regulation. In Sweden, the Stockholm Stock Exchange was opened in 1863.

  2. For example, the Turku Stock Exchange (Turun Arvopaperipörssi) was opened on March 13, 1919. The trading was very modest compared to the Helsinki Stock Exchange (e.g., FIM 7.97 million in 1919) and the exchange was closed after few years of operation in 1922.

  3. This assertion is based on anecdotal evidence in Tiderman (1937) and Stjernschantz (1987).

  4. In addition, it seems that a number of companies that were not officially listed had their shares traded unofficially (e.g. Talousmies newspaper quotes in September 1928 prices for close to 30 stocks that were not listed on the stock exchange).

  5. In October 1929, the Nyberg–Vaihekoski index that we use to proxy for the stock market returns 1912–1969 rose 1.70 % in nominal value. In November, it rose by approximately 2.8 %. Thus, the Black Tuesday in New York does not appear to have affected the Finnish stock market to a large degree. One potential explanation is that the Finnish stock market had sunk approximately 22 % during the previous 12 months, whereas the Dow Jones index reached its highest value in September the same year (Siegel 1998).

  6. As a minor detail, one could mention Suomen Arvopapereita Oy, which was established in 1932. It resembled in a number of ways present-day ETFs. Investors were able to buy the participating certificates freely from the market; prices for the certificates were commonly quoted in daily newspapers. If the price of the certificate deviated too much from the underlying assets (portfolio of selected listed stocks), more certificates were issued.

  7. The number of listed stock series is higher than the number of companies since several companies have two common stock classes listed—the ordinary and the preference share series. They differ typically by their amount of voting rights and/or rights to monetary distributions. The maximum difference in voting rights is set by the company law and it is currently 1:20 (see Vaihekoski 2004, for more details).

  8. For more information of the more recent history of the Helsinki Stock Exchange see, e.g., Stjernschantz (1987) and Vaihekoski (1997).

  9. The early history of the money markets is reviewed in Autio (1996).

  10. In addition, there were already market-born attempts to evade the regulation and restrictions on loan rates. Banks set up financial companies to loan money on more flexible terms. The size of the unregulated money market also started to increase. The largest companies were also able to resort to European money markets.

  11. From 1994 onwards, the rates are calculated as the average of the quotations excluding the highest and the lowest given by the five largest banks.

  12. For more information on the Finnish money markets, see Niskanen (1996).

  13. Since the merger of the HEX and Swedish OMX in 2004, the index has been called the OMX Helsinki (OMXH) index. See Nyberg and Vaihekoski (2010) for more detailed discussion of the indices.

  14. More details can be found from the “Appendix”.

  15. See, for example, Henry (2000) and Bekaert and Harvey (2000) who present empirical evidence that the equity premium tends to decrease after financial market liberalizations.

  16. At the end of the 1940s, real Finnish equity values were approximately only 36 % of their corresponding values from the beginning of the decade. In comparison, equity values in Germany declined to 28 % and equity values in Japan declined to 5 % of earlier values (Jorion and Goetzmann 1999).

  17. Reinhart and Rogoff (2009) provide an international comparison on the effects of banking crisis on the stock market; the Finnish stock market suffered clearly more than the historical average of the cases analyzed. Kuusterä and Tarkka (2012) provide more detailed information on the banking crisis in Finland. Antell and Vaihekoski (2012) review the history of Finnish and Swedish currency regimes since the Bretton Woods agreement.

  18. More detailed results are available upon request.

  19. The results differs slightly what Dimson et al. (2010) estimated from 1910 to 2009. Using their equity premium index, one can estimate the equity premium to be 5.57 % for Finland, 4.83 % for the USA, and 3.65 % for Sweden.

  20. The mean values in Table 1 differ from those reported here due to the well-known relationship between the lognormal distribution (percentage returns) and the normal distribution (continuously compounded returns) which implies, for example, that the arithmetic average of percentage returns exceeds the average continuously compounded rate by 0.5σ 2. Note also that annualized volatility (Table 1) typically differs from volatility of annual returns due to autocorrelation in returns. Note also that the annual money market returns are proxied as the average of the 1 month returns.

  21. The average correlation between Sweden and USA (not displayed in the figure) is 0.36 during the sample period, that is, more than double the correlation between Finland and USA.

  22. It must, however, be noted that this extreme level of concentration mentioned here is a peculiarity of the later years in our sample and is not characteristic for the whole time period. For example, at the beginning of 1975, the largest company made up approximately 12 % of the total stock market value, whereas the three largest companies accounted for approximately 35 % of total market value. At the beginning of 1990, the largest company accounted for 8 % of the total value, and the three largest companies for 20 %.

  23. The index was also published in the Statistical Yearbook for Finland (accurate index values given) and Bank of Finland Monthly Bulletin (rounded index values given), among others.

  24. Issue 6 from 1937 discusses the construction in details.

  25. Somewhat mysteriously, the quarterly index has been published only in the Statistical Yearbook 1921 as far as we know. Index values for 1917–1919 are given using marginal prices as well as prices from the black market as the basis for the index construction. The latter one is used in this study.

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Acknowledgments

We are grateful for the comments from an anonymous referee, Kristian Rydqvist and David Le Bris as well as for those received at the 28th International Conference of the French Finance Association (AFFI) in 2011. We also gratefully acknowledge the financial support from the NASDAQ OMX Nordic Foundation.

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Authors and Affiliations

  1. Department of Finance, Aalto University School of Business, P.O. Box 1210, 00101, Helsinki, Finland

    Peter Nyberg

  2. Department of Accounting and Finance, Turku School of Economics (TSE), University of Turku, 20014, Turku, Finland

    Mika Vaihekoski

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  1. Peter Nyberg
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Correspondence to Mika Vaihekoski.

Appendix: Construction of the time series

Appendix: Construction of the time series

1.1 Finland

The money market (risk-free) rate of return for month t is calculated using the following equation: r t  = 100(P t−1)−1, where P t−1 = 100(1 + i × d)−1. The money market rate, i, is either 1 month Helibor rate (31.12.1986–31.12.1998) or Euribor rate (31.1.1999–) observed at the end of the previous month. The parameter d is the real number of days between from the month end t–1 to t divided either by 365 (Helibor) or 360 (Euribor). For the period before 1987, Bank of Finland’s base rate is used. The approach used to derive monthly rates of return from the Helibor rates is also applied to the base rate.

The value-weighted total return index in Nyberg and Vaihekoski (2010) has been used to calculate value and equally weighted stock market returns from 1912 to March 1970. Few errors have been corrected in the original index but the impact is minuscule. Both the old and the new index are available at the author’s Web site.

Inflation series is calculated using the official monthly Cost of Living index that is available from January 1921 onward. At first, the index was calculated by the Research Office of the Ministry for Social Affairs and published in Sosiaalinen Aikakauskirja (Journal of Social Issues).Footnote 23 The reference period was initially set to the first half of 1914 (i.e., 1914/1–6 = 100). The index as such was calculated officially until the end of 1936.

In 1936 and 1937, a meeting between economic statisticians from Nordic countries was held in Copenhagen. The participating countries decided to harmonize their indices and, as a result, 1935 was set as the new reference period for a number of indices, including the Cost of Living index. At the same time, a decision was made that the index will only be calculated quarterly, during the first month of each quarter. However, subindices for food, heating, and lighting would still be calculated on a monthly basis. The new officially quarterly index (1935/1–12 = 100) was published in the Journal as before, but the Bank of Finland also calculated unofficial values for the intervening months using the above-mentioned monthly subindices. The Bank published the index values in their Monthly Bulletin publication.Footnote 24 These index values are used in this study.

From August 1939 onward, the Cost of Living index has been available at the monthly level. It can be easily derived from the electronic databases, e.g., through Statistics Finland. For this study, an index that covers the period from August 1939 until the present day was constructed by splicing two indices with reference periods 1938/8–1939/7 = 100 and 1951/10 = 100.

The period before 1921 is more problematic from a researcher’s point of view as most sources provide only annual values for the index. However, one can use an unofficial index calculated by the Research Office of the Ministry for Social Affairs. They calculated two indices for living costs, both of which had the same reference period (1914/1–6 = 100), but they differed in how they handled taxes. The one used here did not take into account changes in taxes, but it is available for 1920–1921 on a monthly basis. In addition, it is also available on a quarterly basis for the period from 1914 to the end of 1919.Footnote 25 For the period prior to 1914, index values for the cost of living are only available on a yearly basis. Therefore, for 1912–1913, we have used yearly values of the cost of living index published in Hjerppe (1989). Quarterly and annual changes in index values are transformed into monthly inflation rates under the assumption of a constant rate of inflation during the intervening months. In other words, we calculate the monthly rate corresponding to effective (compounded) quarterly (annual) rate of changes.

1.2 Sweden

The risk-free rate of return proxy for Sweden is calculated using the monthly short-run yield series provided at the Riksbank’s (Bank of Sweden) Web site. Values are provided to the end of 2006 after which we use 30-day T-bill rates taken from Datastream. The values for 1912–1981 are the discount rate (corresponding to Finnish base rate) of the Riksbank and Swedish 30-day Treasury bills (Statsskuldsväxlar) market yields thereafter. The data provided by the Riksbank differ occasionally slightly from Frennberg and Hansson (1992) but for the most part the values are identical. Monthly returns are calculated similar to Finland, but using the real/360-day counting convention throughout the period.

Swedish stock market returns are calculated using stock market index provided at the Riksbank’s Web site. It seems that their data for 1918–1989 are originally by Frennberg and Hansson (1992) and for 1912–1917 by Waldenström (2007). Note that period 1912–1917 excludes dividends. For the period after 2006, we augment first with the general index by Affärsvärlden (year 2007) and then with the Stock Exchange’s own index OMXS (2008–). Both total return indices are taken from Datastream.

Swedish inflation is calculated using the CPI index provided in Frennberg and Hansson (1992) for period 1919–1989 after which we calculate the official CPI index by Statistics Sweden. For 1912–1916, we calculate the monthly inflation using the annual inflation index provided by the Riksbanken. For 1917–1918, we use the quarterly CPI index by Statistics Sweden. Monthly rates are calculated as for Finland.

1.3 USA

For the USA, we use the risk-free return series based on the US Treasury Bills. The series is available since 1926 and taken from Ibbotson SBBI. For a period prior to 1926, the selection of the risk-free rate of return is more problematic as there were no T-Bills (see, e.g., Mehra and Prescott 2003, for discussion). Here, we utilize call money yields taken from FRED. To derive monthly returns from the yields, we have used the same approach as before, but the pricing equation used is taken from SBBI, i.e., P t−1 = 100(1 − i × d)−1. Real/360-day counting convention is used. To derive implied money market yields for Fig. 5, we have used the pricing equation backwards.

US stock market returns have been calculated using the Standard and Poor’s composite index (dividends added separately) as a proxy for the market index from 1912 to June 1926 after which we have used CRSP value-weighted index. Series have been taken from Professors Robert J. Shiller’s and Kenneth R. French’s Web sites.

US inflation is calculated using the official CPI index (All Urban Consumers). Monthly values are available from January 1913 forward from FRED. Values for 1912 are taken from Professors Robert J. Shiller’s Web site. His values for 1913–2005 match the values from FRED with minor differences in 2005.

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Nyberg, P., Vaihekoski, M. Equity premium in Finland and long-term performance of the Finnish equity and money markets. Cliometrica 8, 241–269 (2014). https://doi.org/10.1007/s11698-013-0101-7

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