Abstract:
Institutional environments with good governance would lead to higher stock market
returns by reducing both transaction and agency costs. Meanwhile, superior
institutional environments ensure lower levels of uncertainty, resulting in lower
returns on equity. Therefore, this study investigates the effect of institutional quality
on the performance of global stock markets. Due to the persistence behavior of stock
market development (SMD), a dynamic econometric model is developed in this
regard. SMD is proxied by market capitalization to GDP ratio. A Proxy for
institutional quality is obtained by the common component of governance indices that
measure the effectiveness of government, regulatory quality, extent of corruption
control, political stability, voice and accountability, and agents’ confidence on the
rules of the society. Several other empirically chosen variables are also included to the
model to control the other potential effects. A panel data set of 43 countries over the
period 2005 to 2013 is measured using Generalized Method of Moment (GMM)
estimation techniques. Results depict a negatively significant relationship between
SMD and the institutional quality. The relationship continued to remain negative
when the model is robusted for developing and developed countries. Interestingly, the
risk-return spectrum is supported when the model is further robusted for countries
with strong and weak Institutional environments.
