To liberalize or not to liberalize, that is the question many developing markets wrestle with. If you open up your markets you could be opening up to chicanery, volatility and a noncompetitive increase in the cost of capital as a result. If you don’t, you could lose the benefits of better actors and the improved best-practice their presence usually implies.
The paper highlighted today from Binzhao Lin (et al.) from Xiamen University takes a look at China’s stock connect program and the effect it had on domestic shares in Shanghai and Shenzhen when outsiders were able to get access.
The conclusions are short but sweet from the point of view of how they might inform regulators and policymakers considering opening up their own markets.
In brief they found as follows:
- The connect programs significantly reduced stock tail systemic risk i.e. after the opening up the riskiness of stocks, especially when the overall market was stressed, declined.
- The mechanism for this seems to be better information, better corporate governance and better liquidity (leading to greater interest, coverage and scrutiny)
- “The risk mitigation effect of this policy [Was] particularly pronounced in areas with weaker investor protection.”
So, discussion over. In this case at least letting outsiders in worked for everybody’s benefit. Moreover, this seemed to be a classic case of sunlight being an effective disinfectant.
The researchers sign off noting that the opening up of China’s financial markets has been partial to date but, based on their work, there seem to be more benefits to be gained from the system by continuing with the reform.
You’ll find the work in full via this link Stock Connect and Risk Reduction
Happy Sunday.