Institutional quality is important for stock market development because efficient and accountable institutions tend broaden appeal and confidence in equity investment. Equity investment thus becomes gradually more attractive as political risk is resolved over time.
Therefore, the development of good quality institutions can affect the attractiveness of equity investment and lead to stock market development. Yartey (2007a) finds good quality institutions such as law and order, democratic accountability, bureaucratic quality as important determinants of stock market development in Africa because they reduce political risk and enhance the viability of external finance. Bekaert (1995) provides evidence that higher levels of political risk are related to higher degrees of market segmentation and consequently low level of stock market development. Erb et al (1996a) show that expected returns are related to the magnitude of political risk. They find that in both developing and developed countries, the lower the level of political risk, the lower is required returns. The evidence in the literature suggests that political risk is a priced factor for which investors are rewarded and that it strongly affects the local cost of equity, which may have important implications for stock market development.
IMF Working Paper African Department Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges Prepared by Charles Amo Yartey and Charles Komla Adjasi August 2007
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International Monetary Fund
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The IMF is an international organization
of 185 member countries. It was
established to promote international
monetary cooperation, exchange stability,
and orderly exchange arrangements; to
foster economic growth and high levels of
employment; and to provide temporary
financial assistance to countries to help
ease balance of payments adjustment.
Since the IMF was established its purposes
have remained unchanged but its
operations—which involve surveillance,
financial assistance, and technical
assistance—have developed to meet the
changing needs of its member countries in
an evolving world economy.
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