The higher liquidity of securities in this market appears as one of the major reasons which have made stock markets as major choice of investors as compared to other kinds of investments like real estate investments. The increasing number of multinational companies and open access to foreign investors has further boosted the activities of stock markets in the emerging economies. The aim of this essay is to analyse the role a stock market plays as a transmission mechanism to attract foreign direct investment as capital inflows. Through critical analysis of research findings and opinions of early researchers, the topic has been investigated.
Both for small and large companies, stock markets appear as a major source of raising capital and these companies further use the capital in the expansion of the organisation. Therefore, by providing liquidity to companies, stock market plays a very significant role in supporting financial systems of companies. The internationalisation of world’s capital markets has enhanced the role of equity markets in encouraging capital inflows. Woepking (2007) argues that internationalisation of capital markets have given opportunity to investors to diversify their risk. Investors like individuals and companies diversify the risks of their portfolios by investing in equity markets of foreign companies. The foreign direct investments capital inflow is increasing in the emerging economies. In 1995, total foreign direct investment to developing economies increased by 38 percent of global FDI and rose to US $95 billion as compared to US $25 billion and 12 percent of global FDI in 1990 (Wilhelms & Witter, 1998). Foreign direct investment as a direct investment is considered very important in modernizing the national economy and its growth (Alfaro, Chanda, Ozcan & Sayek, 2000). Therefore, it is interesting to discuss whether increasing foreign direct investment