Equity Markets and Economic Development: What Do We Know

3. Conclusion

Two salient facts have emerged from this literature survey. First, the impact of equity market
development on the allocation of investment seems to be determined by the extent of
informational transparency (Bekaert & Harvey, 2001, Capasso, 2004). Second, the integration
of local equity markets into global finance appears to have mixed consequences. Asset pricing
models underline a diminution of the risk-premium following integration, resulting in a lower
cost of capital for local businesses (Stulz, 1999). But on the other hand, increases in
international covariances exert a positive impact on financial vulnerability. Financial
integration may increase shock sensitivity and financial contagion (Bekaert, Harvey & Ng,
2003). Increases in international correlations also undermine the benefits of portfolio
diversification for foreign investors, resulting in a mixed impact on capital flows (Arouri,
2001; Baroumi, 2005). The overall policy message is thus ambiguous. Theory shows that the
effectiveness of policies seeking to enhance the allocative function of equity markets is
conditioned by the extent of informational efficiency. We can hence suggest that equity
market development policies should focus on reaching and maintaining adequate levels of
institutional transparency, regardless of the level of international integration, which depends
in last resort on the society’s preference between international accessibility and domestic
stability.

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