Financial Openness and Financial Development: Evidence from Emerging Countries

Abstract

We investigate the potential relation between financial openness and financial development for 27 emerging countries for the period between 1996 and 2016. We focus on three dimensions of financial openness: capital account openness, trade openness, and stock-market openness. In this study, we propose alternative measures for capital account and trade openness. Moreover, we offer capital flow and valuation-based measures for stock-market openness as a potential determinant of financial development. Our findings indicate that capital account openness and trade openness are the key drivers of financial development. These results are not sensitive to the use of alternative financial openness and financial development measures, and are robust after being controlled for institutional quality and its components. Our results have implications for policymakers in emerging countries who try to increase the depth of their financial markets for an easier and cheaper access to funds.

Keywords

• Financial Development
• Trade Openness
• Capital Account Openness
• Stock Market Openness

References

1. Ahmed, A. D. (2013). Effects of financial liberalization on financial market development and economic performance of the SSA region: An empirical assessment Economic Modelling, 30, 261–273. https://doi.org/10.1016/j.econmod.2012.09.019
2. Baltagi, B. H., Demetriades, P. O., and Law, S. H. (2009). Financial development and openness: Evidence from panel data, Journal of Development Economics, 89(2), 285-296. http://dx.doi.org/10.2139/ssrn.1808903
3. Bayar, Y. (2016). Foreign capital inflows and financial development in central and eastern european countries, CASE-Center for Social and Economic Research Conference “The Future of Europe”, 17—18 November, Warsaw, Poland.
4. Bayar, A., & Önder, Z. (2005). Liquidity and price volatility of cross-listed French stocks, Applied Financial Economics, 15, 1079-1094. https://doi.org/10.1080/09603100500187083
5. Beck, T., Demirgüç-Kunt, A. & Levine, R. (2010). Financial institutions and markets across countries and over time: The updated financial development and structure database, The World Bank Economic Review, 24(1), 77–92. https://doi.org/10.1093/wber/lhp016
6. Bekaert, G. & Harvey, C.R. (2000). Foreign speculators and emerging equity markets, The Journal of Finance, 55(2), 565-612. https://doi.org/10.1111/0022-1082.00220
7. Bekaert, G., Harvey, C.R., & Lundblad, C. (2005). Does financial liberalization spur growth. Journal of Financial Economics , 77, 3-55.https://doi.org/10.1016/j.jfineco.2004.05.007
8. Bekaert, G., Harvey, C.R., Lundblad, C.T. & Siegel, S. (2011). What segments equity markets?, The Review of Financial Studies, 24(12), 3841-3887. https://doi.org/10.1093/rfs/hhr082

9. Chari, A. and Henry, P.B., (2004). Risk sharing and asset prices: Evidence from a natural experiment,” The Journal of Finance 59, 1295-1324. http://dx.doi.org/10.2139/ssrn.354840
10. Chinn, M. D. & Ito, H. (2006). What matters for financial development? Capital controls, institutions and interactions, Journal of Development Economics, 81, 163-192. https://doi.org/10.1016/j.jdeveco.2005.05.010
11. Gujarati, D.N. and Porter , D.C. (2009). Basic Econometrics, 5th edition, McGraw-Hill/Irwin, New York, USA.
12. Hair, J.F., Black, W.C., Babin, B.J., & Anderson, R.E. (2009). Multivariate Data Analysis, 7th Edition Pearson Prentice Hall.
13. Henry, P. B. (2000a). Stock market liberalization, economic reform and emerging market equity prices. Journal of Finance , 55 (2), 529-564. https://doi.org/10.1111/0022-1082.00219
14. Henry, P. B. (2000b). Do stock market liberalizations cause investment booms? Journal of Financial Economics , 58 (1), 301-334. https://doi.org/10.1016/S0304-405X(00)00073-8
15. Huang, Y. & Temple, J.R.W. (2005). Does external trade promote financial development?, CEPR Discussion Paper No. 5150.
16. Jayasuriya, S. (2005). Stock market liberalization and volatility in the presence of favorable market characteristics and institutions, Emerging Markets Revie, 6, 170–191. https://doi.org/10.1016/j.ememar.2005.03.001
17. Kim, E.H. & Singal, V. (2000). Stock market Openings: Experience of emerging economies, Journal of Business, 73 (1), 25-66. https://doi.org/10.1086/209631
18. Kim, D-H., Lin, S-C. and Suen, Y-B. (2010). Dynamic effects of trade openness on financial development, Economic Modelling, 27, 254–261. https://doi.org/10.1016/j.econmod.2009.09.005
19. Klein, M. & Olivei, G. (2008). Capital account liberalization, financial depth, and economic growth, Journal of International Money and Finance, 27, 861–875. https://doi.org/10.1016/j.jimonfin.2008.05.002
20. Lane, P. R., & Milesi-Ferretti, G. M. (2007). The external wealth of Nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970–2004, Journal of International Economics, 73, 223–250. https://doi.org/10.1016/j.jinteco.2007.02.003
21. Law, S.H. (2009). Trade openness, capital flows and financial development in developing economies, International Economic Journal, 23(3), 409–426. https://doi.org/10.1080/10168730903268398
22. Law, S.H. & Habibullah, M.S. (2009). The determinants of financial development: Institutions, openness and financial liberalisation, South African Journal of Economics, Vol. 77(1), 45-58. https://doi.org/10.1111/j.1813-6982.2009.01201.x
23. Levine, R., Loayza, N. & Beck, T. (2000). Financial intermediation and growth: Causality and causes. Journal of Monetary Economics, 46, 31-77. https://doi.org/10.1016/S0304-3932(00)00017-9
24. Miniane, J. (2004). A new set of measures on capital account restrictions, IMF Staff Papers, 51(2), 276-308. https://doi.org/10.2307/30035876
25. Motelle, S. I. (2011). The role of remittances in financial development in Lesotho: Evidence from alternative measures of financial development, Journal of Development and Agricultural Economics, 3(6), 241-251.
26. Pesaran, M. H. (2004). General diagnostic tests for cross section dependence in panels, Cambridge Working Papers in Economics No. 435, University of Cambridge, and CESifo Working Paper Series No. 1229. https://doi.org/10.17863/CAM.5113.
27. Pesaran, M.H. & Yamagata, T. (2008). Testing slope homogeneity in large panels. Journal of Econometrics, 142, 50–93. https://doi.org/10.1016/j.jeconom.2007.05.010
28. Rajan, R.G. & Zingales, L. (2003). The great reversals: The politics of financial development in the twentieth century, Journal of Financial Economics, 69(1), 5–50. https://doi.org/10.1016/S0304-405X(03)00125-9
29. Squallli, J. & Wilson, K. (2011). A new measure of trade openness, The World Economy, 34(10), 1745-1770. https://doi.org/10.1111/j.1467-9701.2011.01404.x
30. Stulz, R. M. (1999). Globalization, corporate finance and the cost of capital. Journal of Applied Corporate Finance, 12 (3), 8-25. https://doi.org/10.1111/j.1745-6622.1999.tb00027.x
31. Umutlu, M., Akdeniz, L. & Altay-Salih., A. (2010). The degree of financial liberalization and aggregated stock-return volatility in emerging markets, Journal of Banking & Finance, 34, 509–521. https://doi.org/10.1016/j.jbankfin.2009.08.010
32. Umutlu, M., Altay-Salih, A. & Akdeniz, L. (2010) Does ADR listing affect the dynamics of volatility in emerging markets? (2010) Finance a Uver-Czech Journal of Economics and Finance 60, 122-137.
33. Valickova, P., Havranek, T. & Horvath, R. (2015). Financial development and economic growth: A meta-analysis, Journal of Economic Surveys, 29(3), 506–526. https://doi.org/10.1111/joes.12068
34. World Bank, (2018, December). World governance index. WGI Indicators. Retrieved from http://info.worldbank.org/governance/wgi/index.aspx#doc