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Firm-Specific Variation and Capital Openness

The extent to which individual stock prices move independently varies both across countries and over time. Morck et al. (2000) show that individual stock prices rise and fall concurrently more than in lower income economies in the mid 1990s. Campbell et al. (2001) and Morck et al. (2000) find a long-term rise in firm-specific variation in US stock returns, and a consequent decline in stock price comovement in that country.

We document analogous changes in the individual stock returns in some, but not all emerging markets. Panel regressions reveal a highly significant and robust link between greater capital market openness and higher firm-specific variation. This effect is most evident in emerging market economies with sound institutions. Indeed, capital market openness and poor institutions may actually increase comovement. Similar effects are not evident for trade openness.

These results are important in several ways. Since Wurgler and Durnev et al. (2003) link more idiosyncratic returns to more efficient capital allocation, capital market openness might perhaps improve capital allocation. Since trade openness is unrelated to comovement, greater specialization seems an implausible explanation. The heightened linkage between capital market openness and idiosyncratic variation in the presence of good institutions supports the finding of Morck et al. (2000) that idiosyncratic variation is somehow related to the institutions of the stock market and of private property.

The remainder of the paper is arranged as follows. Section two describes our conceptual starting points. Section three describes our methodology and section four presents our empirical findings. Section six concludes.

Firm-Specific Variation and Capital Openness