Henry, Peter Blair, 2000, “Do stock market liberalizations cause investment booms?” Journal of Financial Economics 58 (2000), 301-334.
Purpose: To show that liberalizing a country’s stock market leads to increased private investment.
Motivation: International asset pricing theory predicts that a stock market liberalization will be accompanied by a rise in the liberalizing country’s equity prices and by increased investment in physical capital. Prior research has empirically confirmed the first prediction. This paper investigates the second.
Findings: In countries that liberalize their equity markets, where the marginal product of capital is high and domestic cost of capital exceeds the world average, private investment significantly and meaningfully rises.
Data/Methods: This is an event study of liberalization in a sample of 11 emerging-market countries.
- Determine dates of liberalization by using date of government mandate, date of first country mutual fund, or date of a jump in the IFC’s Investability Index.
- Obtain private investment data from the World Bank’s STARS database (Socioeconomic Time Series Access and Retrieval).
- Find stock returns in local currencies (including dividends) in the IFC Global Index, from the IFC’S Emerging Markets Database (EMDB).
- Regress changes in log investment on dummies for the year of liberalization and the two following.
- Include calendar year dummies to control for global macroeconomic trends.
- Regress changes in log investment on stock returns and lagged stock returns.
- Again include calendar year dummies.
- Also use real U.S. interest rates and OECD output growth rates to control for world business cycles.
- Use dummies to control for other simultaneous reforms: macroeconomic stabilization programs, trade liberalizations, privatization programs, and reductions of exchange controls.
- Also control for domestic fundamentals, such as GDP growth.
- Market liberalization leads to increased stock prices.
- Growth in private investment is strongly correlated with changes in stock prices.
- The correlation is stronger for valuation changes related to liberalization.
- Private investment increases after liberalization, even after controlling for global cycles.