Do Stock Markets Liberalizations Cause Investment Booms?

By Peter Blair Henry
1999| Working Paper No. 1504

Stock market liberalizations lead private investment booms. In a sample of 11 developing countries that liberalized, 9 experience growth rates of private investment above their non-liberalization median in te first year after liberalizing. In the second and third years after liberalization this number is 10 of 11 and 8 of 11 respectively. The mean growth rate of private investment in the three years immediately following stock marekt liberalization exceeds the sample mean by 22 percentage points. The relationship between private investment growth and stock market liberalization persists after controlling for worl business cycle effects, contemporaneous economic reforms, and domestic fundamentals. Because the possibility of reverse casuality cannot be ruled out, we cannot conclude that stock market liberalizations cause investment booms. Nevertheless, the evidence stands in sharp contrast with recent work that suggest capital account liberalizations has no effect on investment.