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Do Stock Market Liberalizations Cause Investment Booms?

Stock market liberalization has a strong positive effect on investment. I document this result for a cross section of emerging markets and show that the relationship holds even when controlling for economic reforms and changes in other fundamental values. There are three principal components to this finding. First, in each of the two years immediately following liberalization, the growth rate of private investment is 10 and 13 percentage points greater than the sample mean respectively. Second, increases in stock market valuation that are caused by liberalization predict larger subsequent increases in the growth rate of investment than generic valuation increases. Finally, in addition to the investment surge it causes by driving up stock prices, liberalization also increases investment through a channel that operates independently of the liberalization-induced increase in valuation. After controlling for stock returns, investment is still 12 percent points higher than the sample mean in the second year after liberalization. The analysis is a natural experiment of the kind proposed by Fisher and Merton (1984) and suggests that stock market liberalization provides a valuable impetus to the economic reform process.

Peter Henry
Publication Date
November, 1997