Growth Volatility and Equity Market Liberalization

Abstract

If there are benefits to international risk sharing, consumption growth variability should decrease following the liberalization of the equity market. In addition, markets with open equity markets should display lower consumption growth variability than closed markets, everything else equal. However, the recent literature on financial liberalization suggests that volatile capital flows lead to increased output and consumption growth variability post liberalization. In this article, we examine the effects of equity market liberalization on GDP and consumption growth variability. Excluding the 1997-2000 years, dominated by the consequences of the South-East Asia crisis, we find an economically and statistically significant decrease in both GDP and consumption growth variability post liberalization. When the 1997-2000 years are taken into account, the negative volatility response of consumption growth is weakened and is no longer significant for a sample of emerging markets, but remains significant for a larger set of countries. These results hold for both total and idiosyncratic consumption growth volatility. JEL Classification: E32, F30, F36, F43, G15, G18, G28 ∗ We thank Susan Collins for inspiring this paper. We appreciate the comments of Andrew Frankel. Send correspondence to: Campbell R. Harvey, Fuqua School of Business, Duke University, Durham, NC 27708. Phone: +1 919.660.7768, E-mail: cam.harvey@duke.edu .

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