Working Paper: CEPR ID: DP3055
Authors: Luc Laeven; Enrico C. Perotti
Abstract: Investor confidence in reliable property rights and stable, market-oriented policies are a necessary condition for financial integration and the development of emerging stock markets. Announced market-oriented policies may be reversed, however, and are initially not fully credible. We argue that sustained privatization and liberalization programmes represent a major test of political commitment to safer private property rights. We investigate whether successful privatization has a significant effect on emerging stock market development through the resolution of policy risk, i.e. the risk of ex post policy changes with redistributive impact on investment returns. The evidence from our panel study suggests that progress in privatization gradually leads to increased confidence. Moreover, increased confidence has a strong effect on local market development and is a significant determinant of excess returns. We conclude that financial liberalization and the resolution of policy risk resulting from successful privatization has been an important source for the broadening and deepening of emerging stock markets.
Keywords: emerging market; financial integration; liberalization; political risk; privatization; stock market development
JEL Codes: G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sustained privatization (L33) | increased investor confidence (G24) |
| increased investor confidence (G24) | stock market development (G10) |
| successful privatization (L33) | reduction in policy risk (G18) |
| reduction in policy risk (G18) | increased investor confidence (G24) |
| increased investor confidence (G24) | increased stock market capitalization (G10) |
| increased investor confidence (G24) | increased trading volume (G15) |
| sustained privatization (L33) | improved country credit risk ratings (CCR) (F34) |
| improved country credit risk ratings (CCR) (F34) | stock market growth (G10) |
| resolution of policy risk (G38) | excess stock returns (G12) |