Review of Finance Advance Access published online on February 19, 2008
Review of Finance, doi:10.1093/rof/rfn002
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Short-Run Pain, Long-Run Gain: Financial Liberalization and Stock Market Cycles*
1 George Washington University and NBER
2 World Bank
The views on financial liberalization are quite conflictive. Many argue that it triggers financial bubbles and crises. Others claim that financial liberalization allows markets to function properly and capital to move to its most profitable destination. The empirical evidence on these effects is not robust. This paper constructs a new comprehensive chronology of financial liberalization and shows that a key reason for the inconclusive evidence is that the effects of liberalization are time-varying. Financial liberalization is followed by large booms and busts only in the short run. In the long run institutions improve and financial markets tend to stabilize.
JEL Classification: F30, F36, G12, G15
* We have received insightful comments from Franklin Allen (the Editor), Tom Glaessner, Gian Maria Milesi-Ferretti, Raghu Rajan, Linda Tesar, Aaron Tornell, two anonymous referees, as well as participants at presentations held at the American Economic Association Meetings, Brandeis University, the Deutsche Bundesbank, the Federal Reserve Bank of New York, the Federal Reserve Board, the International Monetary Fund, the Society for Economic Dynamics Meeting (New York University), the LACEA Annual Meetings (Madrid), Stanford University, University of Maryland, Universidad Torcuato Di Tella, and the World Bank. We are grateful to José Azar, Francisco Ceballos, Tatiana Didier, Juan Carlos Gozzi, Federico Guerrero, Marina Halac, Cicilia Harun, José Pineda, Arun Sharma, Akiko Terada, Francisco Vazquez, Chris van Klaveren, and Kevin Wang, who helped us with excellent research assistance at different stages of the project. The Research Committee and the Latin American Regional Studies Program of the World Bank kindly provided financial support. The views expressed in this paper are those of the authors and should not be interpreted as reflecting those of the World Bank.