Working Paper: NBER ID: w10560
Authors: Geert Bekaert; Campbell R. Harvey; Christian Lundblad
Abstract: We examine the effects of both equity market liberalization and capital account openness on real consumption growth variability. We show that financial liberalization is mostly associated with lower consumption growth volatility. Our results are robust, surviving controls for business-cycle effects, economic and financial development, the quality of institutions, and other variables. Countries that have more open capital accounts experience a greater reduction in consumption growth volatility after equity market openings. The results hold for both total and idiosyncratic consumption growth volatility. We also find that financial liberalizations are associated with declines in the ratio of consumption growth volatility to GDP growth volatility, suggesting improved risk sharing. Our results are weaker for liberalizing emerging markets but we never observe an increase in real volatility. Moreover, we demonstrate significant differences in the volatility response depending on the size of the banking and government sectors and certain institutional factors.
Keywords: financial liberalization; growth volatility; capital account openness; equity market liberalization
JEL Codes: E32; F30; F36; F43; G15; G18; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial liberalization (F30) | lower consumption growth volatility (F62) |
| more open capital accounts (F32) | greater reduction in consumption growth volatility (F62) |
| financial liberalizations (F30) | declines in the ratio of consumption growth volatility to GDP growth volatility (F62) |
| size of banking and government sectors (G28) | volatility response (C58) |
| equity market liberalization (G18) | substantial reductions in consumption growth variability (D15) |
| capital account openness (F30) | substantial reductions in consumption growth variability (D15) |
| well-developed financial systems and institutions (O16) | reduction in consumption growth variability post-liberalization (F62) |