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Is the Invisible Hand Discerning or Indiscriminate? Investment and Stock Prices in the Aftermath of Capital Account Liberalizations

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  • Anusha Chari
  • Peter Blair Henry

Abstract

We confront the two opposing views of capital account liberalization in developing countries with a new firm-level dataset on investment, stock prices, and sales. In the three-year period following liberalizations, the growth rate of the typical firm's capital stock exceeds its pre-liberalization mean by an average of 5.4 percentage points. The return to capital rises in the post-liberalization period, suggesting that the investment boom does not constitute a wasteful binge. In the cross section, changes in investment are significantly correlated with the signals about fundamentals embedded in the stock price changes that occur upon liberalization. Panel data estimations show that a 1-percentage point increase in a firm's expected future cash flow predicts a 4.1-percentage point increase in its investment; the country-specific shock to the cost of capital predicts a 2.3-percentage point increase in investment; firm-specific changes in risk premia do not affect investment.

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  • Anusha Chari & Peter Blair Henry, 2004. "Is the Invisible Hand Discerning or Indiscriminate? Investment and Stock Prices in the Aftermath of Capital Account Liberalizations," NBER Working Papers 10318, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10318
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    Cited by:

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    2. Andreas Hoffmann, 2019. "Beware of Financial Repression: Lessons from History," Intereconomics: Review of European Economic Policy, Springer;ZBW - Leibniz Information Centre for Economics;Centre for European Policy Studies (CEPS), vol. 54(4), pages 259-266, July.
    3. Geert Bekaert & Campbell R. Harvey & Christian Lundblad & Stephan Siegel, 2007. "Global Growth Opportunities and Market Integration," Journal of Finance, American Finance Association, vol. 62(3), pages 1081-1137, June.
    4. Chari, Anusha & Henry, Peter B., 2002. "Risk Sharing and Asset Prices: Evidence from a Natural Experiment," Research Papers 1736r, Stanford University, Graduate School of Business.
    5. Kukenova, Madina, 2011. "Financial liberalization and allocative dfficiency of capital," Policy Research Working Paper Series 5670, The World Bank.
    6. repec:bla:jfinan:v:59:y:2004:i:3:p:1295-1324 is not listed on IDEAS
    7. Papaioannou, Elias, 2007. "Finance and growth: a macroeconomic assessment of the evidence from a European angle," Working Paper Series 787, European Central Bank.
    8. Ziv Chinzara & Radhika Lahiri & En Te chen, 2012. "Financial Globalisation and Sectoral Reallocation of Capital in South Africa," School of Economics and Finance Discussion Papers and Working Papers Series 286, School of Economics and Finance, Queensland University of Technology.
    9. Gozzi, Juan Carlos & Levine, Ross & Schmukler, Sergio L., 2010. "Patterns of international capital raisings," Journal of International Economics, Elsevier, vol. 80(1), pages 45-57, January.
    10. Neaime, Simon, 2012. "The global financial crisis, financial linkages and correlations in returns and volatilities in emerging MENA stock markets," Emerging Markets Review, Elsevier, vol. 13(3), pages 268-282.
    11. Mr. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," IMF Working Papers 2006/152, International Monetary Fund.
    12. Mitton, Todd, 2006. "Stock market liberalization and operating performance at the firm level," Journal of Financial Economics, Elsevier, vol. 81(3), pages 625-647, September.
    13. Zivanemoyo Chinzara & Radhika Lahiri & En Te Chen, 2017. "Financial liberalization and sectoral reallocation of capital in South Africa," Empirical Economics, Springer, vol. 52(1), pages 309-356, February.
    14. Kerstin Gerling, 2008. "The Real Consequences of Financial Market Integration when Countries Are Heterogeneous," Working Papers 141, Oesterreichische Nationalbank (Austrian Central Bank).
    15. Flavin, Thomas & O'Connor, Thomas, 2010. "The sequencing of stock market liberalization events and corporate financing decisions," Emerging Markets Review, Elsevier, vol. 11(3), pages 183-204, September.
    16. Knill, April M., 2005. "Taking the bad with the good : volatility of foreign portfolio investment and financial constraints of small firms," Policy Research Working Paper Series 3797, The World Bank.
    17. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(3).
    18. Chong-Chuo Chang & Oshamah Lin Lin & Oshamah Yu-Cheng Chang & Oshamah Kun-Zhan Hsu, 2023. "Impact of Financial Liberalization on Firm Risk," Advances in Decision Sciences, Asia University, Taiwan, vol. 27(3), pages 14-45, September.

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    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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