DOES FINANCIAL MARKET DEVELOPMENT STIMULATE SAVINGS? EVIDENCE FROM EMERGING STOCK MARKETS

I. INTRODUCTION More generally, the creation of new saving instruments and financial market development in a stable macroeconomic environment could in turn further stimulate saving. Bank for International Settlements, 66th Annual Report, 1996 Equity markets are a vital part of economic development - they encourage savings, help channel savings into productive investment, and encourage entrepreneurs to improve the efficiency of investments. World Institute for Development Economics Research, 1990 The above quotes are representative of a commonly held assumption that financial market development will stimulate savings. This belief exists despite the fact that economic theory provides ambiguous predictions. The predicted relation depends on how financial market development will affect the expected returns and risk of savings, as well as on the form of the utility function. The link between financial market development and savings is considered important because savings is viewed as one of the channels through which financial market development spurs growth (see Pagano, 1993). Understanding how financial market development affects savings, therefore, may provide some insight into long-run economic growth. To date, the empirical relation between financial market development and savings has proven difficult to test. The primary stumbling block has been the lack of a good proxy for financial market development. For example, many empirical studies attempt to measure financial market development by the degree of financial intermediation. Precise measures of savings alternatives such as the number of bank branches or deposit vehicles, however, are not available across a large number of countries, while readily available measures such as the Money/GDP ratio are difficult to interpret. This paper uses an alternative proxy for financial market development, the stock market, to examine the relation between financial market development and savings in emerging markets. The stock market proxy for financial market development has several advantages. First, the stock market represents an important aspect of financial market development because it provides an alternative vehicle for raising capital and because it gives individuals the opportunity to diversify their risks and potentially increase the returns to their savings. Second, stock market data are available for many countries. As a result, proxies for stock market development can be estimated and compared across different countries. Third, because the stock market's role in financial market development can be different from and complementary to that of the banking sector, a study of the impact of stock market development may provide new insights on the effects of financial market development not revealed in studies based on banking sector proxies.(2) This study differs from previous research in that it focuses exclusively on emerging market countries. Levine and Zervos (1998), e.g., estimate the impact of stock market development on private savings using a combined sample of industrial and developing countries, but they do not test whether the savings response differs across the two groups of countries. There are several reasons why emerging markets should be examined separately, however. First, emerging markets have experienced significant changes in their stock markets over the last 10-15 years. Market capitalization in emerging market countries increased by 20 times between 1982 and 1993, while value traded increased by 48 times (International Finance Corporation, Emerging Markets Factbook, 1994, 1995). In contrast, market capitalization and value traded in industrial countries increased by less than five and nine times, respectively. Second, as noted by Claessens (1995), the stock market has been a relatively more important source of external finance for firms in developing countries than for firms in industrial countries. …