Giannetti, Mariassunta () (Dept. of Finance and SITE, Stockholm School of Economics) Koskinen, Yrjö () (Dept. of Finance, Stockholm School of Economics)
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Anecdotal evidence suggests that investor protection affects the demand for equity, but existing theories emphasize only the effect of investor protection on the supply of equity. We build a model showing that the demand for equity is important in explaining financial development. If the level of investor protection is low, wealthy investors have an incentive to become controlling shareholders and pay a high price for their stocks, because they can earn additional benefits by expropriating outside shareholders. As a consequence of lower expected returns both domestic and foreign portfolio investors have a disincentive to hold stocks. The model implies that differences in stock market participation rates across countries and the pervasiveness of home equity bias depend on the degree of investor protection. Additionally, we uncover a good country bias in investment decisions as portfolio investors from countries with low level of investor protection hold relatively more foreign equity. We provide novel international evidence on stock market participation rates, and on holdings of domestic and foreign stocks consistent with the predictions of the model.
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Length: 48 pages Date of creation: 05 May 2003 Date of revision:
14 May 2003 Handle: RePEc:hhs:hastef:0526
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Find related papers by JEL classification: F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
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Luigi Guiso & Paola Sapienza & Luigi Zingales, 2005.
"Trusting the Stock Market,"
NBER Working Papers
11648, National Bureau of Economic Research, Inc.
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