Institutional quality, macroeconomic factors and stock market volatility: A cross-country analysis for pre, during and post global financial crisis

Abstract

This paper investigates how stock market volatility of Ten (10) developed and Seven (7) emerging economies were affected by the institutional quality and macroeconomic factors using data from 2001 to 2012. Applying the standard historical volatility model adopted by Jones et al. (1998) and Andersen and Bollerslev (1998) we find that stock market of the sample countries was volatile during the Global Financial Crisis (GFC) and these effects were statistically significant for the sample emerging countries as well as developed country groups. There is evidence that the sample emerging stock markets exhibited higher stock return volatility than developed stock markets during the observation period. We also find that stock return time-series variables were not stationary over the study period at 1 per cent difference. The study uses the fixed-effects approach to determine the institutional quality and macroeconomic factors that impacted higher stock market volatility for the sample emerging and developed country group. Aligned with institutional theory, we also document that several institutional quality country-level governance indicators and macroeconomic variables are statistically correlated with the stock market volatility during the observation period. For example, we find evidence that some institutional quality and macroeconomic indicators such as rule of law, and credit information have a significantly negative effect on stock market volatility, while other macroeconomic variables such as carbon dioxide (Co2) emission, tax revenue, and board money have a significant positive association with stock market volatility. These findings suggest that our sample markets were volatile not only because of the other macroeconomic factors but also for institutional quality factors. The robustness test also produces similar results with little variation. The findings of this investigation have several policy implications. First, there is evidence that stock markets of the developed and emerging countries were volatile during the GFC and the rule of law appears to be the dominant factor in deterring the stock market volatility. Further, several macroeconomic and fiscal factors, including Co2 emission, tax revenue and board money may seem to be a potential barrier for international investment and portfolio diversification. Therefore, an international investor needs to be careful on portfolio diversification while investing in a poorly structured economy.