Protection Of Property And Stock Synchronicity
February 7, 2001
Stock prices in developing nations move more in sync than stock prices in developed nations. This tends to magnify stock market swings, including price bubbles followed by collapses. Economists have suggested this is due to a lack of economic diversification, the small size of developing markets and reliance on a single industry. However, a recent study claims lack of proper governance causes this synchronicity.
The 1995 study analyzed 16,000 stocks in 40 countries. It finds that synchronicity can be quite large:
- In a given week, 80 percent of stocks move in the same direction in the stock markets of China, Malaysia and Poland.
- By contrast, the stocks gaining value in Ireland, Denmark and the United States barely exceed decliners.
The authors argue that macroeconomic instability, country size and lack of economic diversity do not cause synchronicity. Rather a lack of strong property rights causes it. They use Indonesia as an example:
- In the 1990s, under the Suharto regime, political connections determined ownership rights in Indonesia.
- In 1999, the mere rumor of the deteriorating health of Suharto shaved 25 percent off the values of companies with political connections.
Political connections are more important in countries with poor protection of property, say the authors. Since the governments of those countries tend to be secretive and erratic, individuals invest in politically safe industries rather than profitable ventures. This lets capital flow into unprofitable ventures, causing waste and limiting economic growth.
Source: "Good Government and Stock Synchronicity," Economic Intuition, Fall 2000; based on Randall Morck, Bernard Yeung and Wayne Yu, "The Information Content of Stock Markets, Why Do Emerging Markets Have Synchronous Stock Price Movements?" Journal of Financial Economics, January 2000.
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