Constitutions and Credible Commitments: Estimating Capital Market Responses to Order and Law

Abstract

In this paper I examine the relationship between judicial independence and a country's bond market. Judicial independence is often celebrated both because it provides for the enforcement of economic promises between private parties and political bodies, and because it empowers courts to uphold constitutional commitments to political and civil liberties. Using publicly-available financial data and several measures of judicial independence in 69 countries, I measure the extent to which a highly independent judiciary attracts domestic and foreign investments in government and sovereign bonds. I find a strong correlation between a stable judiciary -- regardless of its independence -- and investment rates. In other words, a judicial independence score that is stable across time is a stronger predictor of investments than a judicial score that is relatively high. These findings tease out a subtle, yet more precise mechanism for the public choice theory of credible commitments.

Keywords: judicial independence, credible commitment, law and economics

JEL Classification: K11, K23, N10, F30, G15, H63