Abstract
This paper investigates whether indicators on the ease of doing business explain variation of financial system vulnerability amongst eight biggest European economics between 1999 and 2014. Using mixed-effects estimation method for sectoral observations nested within countries, the results suggest that easy access to get credit is associated with increased financial vulnerability, as measured by decreased excess return in equity market. The significance of political stability, regulatory quality, and rule of law also marks the role of institutional environment towards vulnerability by facilitating the openness towards new business. Finally, a high degree of openness is not always good especially if they are combined with better institutional environment. This confirms the importance of the level of openness, as well as its channels, in determining the extent of vulnerability.
Highlights
Often associated with larger economies, developed financial systems stimulate the creation of new business, accelerating economic growth [1], while each is enjoying the benefit from fewer restrictions towards international capital flows [2]
The research aims to assess whether liberalization in a country affects the vulnerability of the country’s financial system
Liberalization is represented by the ease of starting a business in a country, while the vulnerability is measured by equity market excess return
Summary
Often associated with larger economies, developed financial systems stimulate the creation of new business, accelerating economic growth [1], while each is enjoying the benefit from fewer restrictions towards international capital flows [2]. They typically have more investment projects, entrepreneurs, investors, and financial institutions serving the role of intermediaries. The excess return was chosen as a proxy for vulnerability. This is motivated by Tsomocos [11], and Aspachs et al [10] who argue that both increased default probability and reduction in aggregate profitability are the key concepts to characterize a vulnerable system and either, or both of them would have an impact upon economic welfare
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