Professional Documents
Culture Documents
liberalization
ADVANTAGES DISADVANTAGES
● Allows capital to move to ● Leads to banking crises
its most attractive ○ Banks’ risky behavior
destination is triggered
● Fosters better ● Triggers short-run
functioning of financial financial booms and busts
markets
● Triggers an increase in
investment rates
Data
◎ Main aspects of liberalization: ◎ 28 countries
○ Liberalization of banking ○ G-7 countries
industry (63 episodes) ○ Asian region
○ Opening up of the capital ○ European region
account (67 episodes) ○ Latin American
○ Liberalization of ◎ 1973-2005
domestic stock market
(49 episodes)
Methodology
INTERNATIONAL DOMESTIC
◎ Bank for International ◎ Annual reports of central
Settlements banks
◎ International Finance ◎ Finance ministries
Corporation ◎ Stock exchanges
◎ IMF
◎ Organization for Economic
Cooperation and
Development
◎ World Bank
Liberalization of Capital Accounts
◎ Evaluate the regulations on offshore borrowing by domestic
financial institutions and offshore borrowing by nonfinancial
corporations, multiple exchange rate markets, and controls on
capital outflows
Partially Liberalized
(PL): at least 2 sectors
are partially
liberalized
Restricted
Pace and Dynamics of Liberalization
Pace and Dynamics of Liberalization
Stock Market
Pace and Dynamics of Liberalization
Capital Account
Domestic Financial
Sector
Pace and Dynamics of Liberalization
Proportion of
episodes in which
the capital account,
the domestic
financial sector, or
the stock market is
liberalized first
Pace and Dynamics of Liberalization
Number of months
from the time the
first market is
deregulated until
the liberalization is
implemented in all
markets
2. Stock Market
Cycle and
Financial
Liberalization
“
There is a large literature that relates
financial liberalization to lending
booms, bubbles in asset prices and
crises. Studying financial cycles is also
relevant to understanding the effects of
financial liberalization.
Stock Market Cycles and Financial Liberalization
◎ Allen and Gorton (1993) developed a model where bubbles can appear if
there are agency problems between investors and portfolio managers.
○ The absence of common knowledge can lead to bubbles in asset prices.
◎ The paper examines the evidence from stock markets in emerging and mature economies
Steps in the determination of cycles
3rd Step
Stock prices and returns
1st Step are examined from the
Identification of cyclical point of view of investors
turning points (looks for 4th Step
holding assets in various
clearly defined swings in 2nd Step Characteristics of
counties (examined
stock market prices in Monte Carlo simulations financial cycles in the
stock prices in one
each country) were used to test that short and long run
international currency)
the random walk does following the deregulation
not capture the basic of financial markets were
properties of the data on compared to examine the
stock prices. effects of financial
liberalization on financial
cycles.
1st Step NBER (National Bureau of Economic Research)
Identification of cyclical
turning points (looks for Methodology
clearly defined swings in
stock market prices in
each country)
◎ Associated with the chronology of expansions and contractions
in the United States.
◎ The paper replicated the NBER methodology using an algorithm
that identifies local maxima subject to constraints on the
minimum duration of the cycle.
◎ Algorithm isolates local minima and maxima in the time series
subject to the constraint that the duration of each cycle cannot
be less than 12 months.
Monte Carlo simulations
2nd Step ◎ All the tests reject the random walk hypothesis at all
Monte Carlo simulations conventional significance levels.
were used to test that
the random walk does ○ Random walks processes - stock price changes have
not capture the basic the same distribution and are independent of each
properties of the data on other, so past movements or trends cannot be used to
stock prices.
predict its future movement.
○ In other words, prices take a random and
unpredictable path.
3rd Step
Stock prices and returns
are examined from the
point of view of investors
holding assets in various
counties (examined
stock prices in one Figure 3: shows stock prices (in logs) and also identifies the booms and
international currency) crashes obtained using the algorithm in the first step
● Shaded area denotes expansion
● 222 cycles over time and across countries, with an average
duration of 42 months
3rd Step
Stock prices and returns
are examined from the
point of view of investors
holding assets in various
counties (examined
stock prices in one Figure 4: Characteristics of the typical cycle in Asia, Europe, G-7 and
international currency) Latin America
● Mean amplitude and duration of booms and crashes
3rd Step
Stock prices and returns
are examined from the
point of view of investors
holding assets in various
counties (examined
stock prices in one
international currency)
Figure 4: Characteristics of the typical cycle in Asia, Europe, G-7 and
Latin America
● Plot of the typical cycle in each region
● Horizontal axis: number of months before and after the peak of the cycle
● Vertical axis: value of the stock index (normalized to 100 at the peak)
Examination of the effects of financial
liberalization on financial cycles
Estimation Results
- Suggests two different patterns
- For emerging, crashes are more
severe following liberalization;
supports previous literature that
liberalization is associated with
excessive financial booms and
crashes
- For mature, larger booms are not
followed by larger crashes,
suggesting that larger booms may
reflect the reduction in the cost of
capital once deregulation takes
place
- In the long run, financial markets
appear to be more stable in both
emerging and mature economies
Ordering of Liberalization
● Examine whether the order of deregulation matters
Rajan and Zingales (2003) argue that well-established firms (& public
officials) may oppose reforms that promote financial development
because it breeds competition, with better disclosure rules and
enforcement
ADVANTAGES
● May change the efficiency of intermediaries
● Expanding domestic capital base
● Capital flight prevents bad policies
● Alleviating “twin agency problem” or government
and corporate expropriate outside investors
Comparing the Timing of Liberalization and Reforms
Index of Law
& Order
Collect data increases by
on quality 1 unit
and laws on
systems
“Index on Law Insider
and Order” by
International Trading
Country Risk Laws
Guide (ICRG)
➢ 28 countries
➢ Shows probabilities that
financial liberalization
occurs conditional on
reforms have already
been implemented
➢ Prob of partial
liberalization (->1) if
governments improve
institutions prior to
deregulation
➢ ->0 if liberalization
triggers reforms
➢ Dynamics between
emerging and mature
economies differ
➢ Emerging: reforms such as
protection of property
rights and insider trading
occur after liberalization
➢ Mature: property rights
protection are in place
➢ Does not improve those
lacking in good property
right or prosecution of
insider trading
As it predates improvements in institutions in emerging markets...
Developed economies:
distortions are less pervasive due to reforms precede
deregulations
amplitudei= α’Xi+ρ1dir+β1dirs +λ1dilr+τ1diL&O+τ2dilTA+τ2dilTE+εi
5%
Crashes declines too (explains mature markets)
0%
Insider Trading Laws impact on financial cycles
Conclusions
Conclusions