Growth Volatility and Financial Liberalization

Abstract:     
We examine the effects of both equity market liberalization and capital account openness on real consumption growth variability. We show that financial liberalization is mostly associated with lower consumption growth volatility. Our results are robust, surviving controls for business-cycle effects, economic and financial development, the quality of institutions, and other variables. Countries that have more open capital accounts experience a greater reduction in consumption growth volatility after equity market openings. The results hold for both total and idiosyncratic consumption growth volatility. We also find that financial liberalizations are associated with declines in the ratio of consumption growth volatility to GDP growth volatility, suggesting improved risk sharing. Our results are weaker for liberalizing emerging markets but we never observe a significant increase in real volatility. Moreover, we demonstrate significant differences in the volatility response depending on the size of the banking and government sectors and certain institutional factors.

Keywords: Consumption growth, equity market liberalization, capital account liberalization, consumption growth volatility, economic volatility, capital account openness, risk sharing, emerging markets

JEL Classifications: F30, F36, F43, G15, G18, G28

Working Paper Series