DP3055 Confidence Building in Emerging Stock Markets

Author(s): Luc Laeven, Enrico C Perotti
Publication Date: November 2001
Keyword(s): emerging market, financial integration, liberalization, political risk, privatization, stock market development
JEL(s): G31
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3055

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.