liberalization of stock markets come three sources: Bekaert, Harvey, and Lundblad (2005), who present official liberalization dates, mostly for developing countries; Kaminsky and Schmukler (2003), who construct an index of the extent of stock market liberalization which also includes developed economies; and Vinhas de Souza (2005), who extends this index to Eastern European countries.<sup>19</sup> We combine these three sources to get the widest possible coverage.<sup>20</sup> Finally, as a measure of “de facto” openness, we use equity flows, including both portfolio equity flows and foreign direct investment (FDI) flows, relative to GDP. This variable captures the effective integration with international capital markets and the “de facto” openness of the stock market; it can also be viewed as a measure of foreign demand for domestic equity.<sup>21</sup> We also control for the possibility that local stock market development is affected by the growth opportunities that firms face. Growth opportunities may be particularly relevant for explaining capital raising behavior, as the literature on initial public offerings (IPOs) has highlighted (see Ritter and Welch, 2002 for a review). Countries with better growth opportunities may need larger stock markets to satisfy a higher demand for external funds. Therefore, we include the global growth opportunities index from Bekaert et al. (2006), which measures how each country’s industry mix is priced in global capital markets, using the price earnings ratios of global industry portfolios.<sup>22</sup> We additionally include GDP as a control variable in our regressions. Securities markets can gain efficiency by expanding their volume and number of participants because of economies of scale and scope and network externalities.<sup>23</sup> Consistent with these arguments, the literature has found the size of the economy to be an important 19 For the data from Kaminsky and Schmukler (2003) and Vinhas de Souza (2005), we consider the first year when a country’s stock market is fully liberalized as the liberalization date. Alternatively, we also used the date of the first partial liberalization and obtained similar results.

20 We also ran regressions using only the Bekaert, Harvey, and Lundblad (2005) dates and their “first sign” stock market liberalization measure, which is based on the earliest of three possibilities: the launching of a country fund, an ADR announcement, and the official liberalization date. We obtained similar results using these measures.

21 We include FDI flows because those flows, apart from new investment, also represent purchases of existing equity. In fact, equity flows are classified as FDI flows when they represent a purchase of at least ten percent of a company’s equity. Note that this variable could be affected by endogeneity, as foreign investment tends to go to countries with more developed financial markets. To reduce this potential problem, and since good instruments are hard to obtain, we use this variable lagged one period. To check that our results are not affected by the inclusion of this variable, we also report estimations without it and find that the coefficients on the rest of the variables are unaffected.

22 Bekaert et al. (2006) use two country-specific industry weightings to calculate each country’s growth opportunities index. One is based on the relative market capitalization of each industry in the local stock market. The other one is based on the relative value added of each industry in the respective country. We report the results using the latter weighting scheme, but also estimated the regressions using the former and obtained similar results.

23 Network effects are an intrinsic feature of securities trading: the benefits of participating in a given market increase with the number of participants (Economides, 1993, 1996 and Di Noia, 1999). This generates positive feedback, as a liquid market attracts more participants and each new participant brings additional trading opportunities and liquidity, benefiting all market participants and making the market more attractive to others. There is also evidence of economies of scale in stock exchange activities, especially regarding order execution (Malkamaki, 1999).

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