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Institutional Quality, Trust and Stock Market Participation: Learning to Forget

  • Asgharian, Hossein

    (Knut Wicksell Centre for Financial Studies, Lund University)

  • Liu, Lu

    (Knut Wicksell Centre for Financial Studies, Lund University)

  • Lundtofte, Frederik

    ()

    (Knut Wicksell Centre for Financial Studies, Lund University)

This paper explores the relation between institutional quality, trust and stock market participation. In our theoretical motivation, agents update their beliefs in a Bayesian manner based on their historical observations on frauds and they choose to invest in the stock market if their subjective probability of fraud is sufficiently low. In accordance with this theoretical motivation, we develop an empirical model, which tests the hypothesis that higher institutional quality is likely to lead to a higher level of trust, together with the hypothesis that when the level of trust is sufficiently high, agents choose to invest in the stock market. We use a large sample of European (SHARE survey) data on households residing in fourteen European countries that have a large variation in institutional quality. We find that institutional quality has a significant effect on trust and that trust (particularly the part that is explained by institutional quality) in turn significantly affects stock market participation. Moreover, our model takes into account the learning process of immigrants, who experience a dramatic change in institutional quality. We find that the probability that an immigrant participates in the stock market increases both with the institutional quality of the country of residence and that of the country of origin. However, on average, the former is more influential than the latter. We also find that immigrants with a higher level of education adapt their level of trust faster to the institutional environment of the country of residence than those with a lower level of education. The impact of the institutional quality of the immigrants’ country of residence on stock market participation, relative to that of their country of origin, tends to increase with education.

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Paper provided by Knut Wicksell Centre for Financial Studies, Lund University in its series Knut Wicksell Working Paper Series with number 2014/2.

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Length: 53 pages
Date of creation: 10 Apr 2014
Date of revision:
Handle: RePEc:hhs:luwick:2014_002
Contact details of provider: Postal: Knut Wicksell Centre for Financial Studies, Lund University School of Economics and Management, P.O. Box 7080, S-220 07 Lund, Sweden
Phone: +46 46-222 32 61
Fax: +46 46-222 34 06
Web page: http://www.lusem.lu.se/kwc

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  1. Larry Epstein & Martin Schneider, 2002. "Learning Under Ambiguity," RCER Working Papers 497, University of Rochester - Center for Economic Research (RCER), revised Mar 2005.
  2. Iris Bohnet & Steffen Huck, 2004. "Repetition and Reputation: Implications for Trust and Trustworthiness When Institutions Change," American Economic Review, American Economic Association, vol. 94(2), pages 362-366, May.
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