How does liberalization affect emerging stock markets? Theories and empirical evidence

Abstract

This paper reviews the literature that discusses how liberalization affects emerging stock markets on the cost of equity, stock volatility, stock liquidity, and informational efficiency. The survey consists of two parts, theoretical arguments and empirical evidence. Four primary mechanisms explaining the impacts are risk diversification, information-sharing, friction channel, and market competition. Our survey indicates that liberalization was evidenced to reduce the cost of equity (via risk diversification mechanism), stabilize stock volatility (mainly through risk diversification mechanism), increase stock market liquidity (in both friction channels and informational-sharing mechanisms), and improve the local market's informational efficiency (by informational-sharing mechanism). Also, we suggest some aspects of theoretical arguments that still need further examination by empirical research.