Factors behind the Development
and Internationalization of
THE PREVIOUS CHAPTER SHOWED THAT capital markets have grown considerably in developed and developing economies over the past two decades, though with high heterogeneity across regions and countries. This growth took place in a context of growing financial globalization—increased cross-border capital flows, substantial foreign direct investment in the financial sector, and securities issuance and trading that was increasingly taking place abroad. In this chapter, we analyze the factors behind the processes of domestic capital market development and internationalization of securities activity. Although the focus in this book is the experience of the Latin American region, the analyses in this chapter encompass the whole available sample of countries. This helps to understand more comprehensively the effects of fundamentals and reforms on capital markets.
We start by focusing on local capital markets and study two types of factors driving their development. First, we analyze the role of macroeconomic and institutional factors, such as monetary stability, fiscal policies, income, and the legal environment. How are economic fundamentals related to capital market development? We address this question by analyzing cross-country evidence on stock and bond markets over a long period. In the case of bond markets, we study not only their size but also their currency and maturity structure, as these issues have elicited significant interest among policy makers and academics alike, given their relevance to recent financial crises. We analyze how institutional factors relate to the currency composition of government bond markets and also discuss why emerging markets tend to borrow short term, even though this type of debt increases their exposure to liquidity crises.
Second, we study the specific role of reforms. Chapter 2 showed that over the past two decades many developing countries undertook extensive