Capitalism and (versus?) democracy: stock markets and democratization in transition

Abstract

This article takes a look at the determinants of democracy in transition economies, with reference to the role of financial markets. Using three different proxies for financial market development, I find that stock exchanges appear to correlate with lower levels of democracy on average, although the most successful democracies also have the largest stock markets. Nonlinearities thus appear to exist in the relationship between financial markets and political institutions in transition.

Keywords:

• democracy
• stock markets
• transition
• institutions

JEL Classification:

• G02
• P26
• B52

Acknowledgement

The author thanks the Bank of Finland Institute for Economies in Transition (BOFIT) for its support and Mikhail Volkov for excellent research assistance.

Notes

¹ The ‘initial’ value for each country is coded as the year before the stock market started operations.

² Country fixed-effects will be accounted for via the inclusion of the three initial conditions variables.

³ The quadratic term for volatility was not included in the IV-GMM regressions due to lack of appropriate instruments; as noted in Table 1, the instrument set for volatility included 6-months of lags in addition to the institutional indicators, which were not appropriate in the quadratic model.