How Do Stock Market Development and Competitiveness Affect Equity Risk Premium? Implications from World Economies

Abstract

Purpose: This paper examines the interrelatedness between countries’ stock market development and competitiveness and the equity risk premium (hereinafter, ERP). In addition, this paper examines the length of time that stock market development takes to have an impact of ERP. The results offer an empirical guide to stock market authorities about the robust factors that help reduce ERP, which, in turn, encourages raising equity financing. Design/methodology: The dataset includes 59 countries that are listed in the market potential index (hereinafter, MPI) covering the years 1996 to 2020. The MPI provides comprehensive macroeconomic factors that can be used for examining stock market competitiveness and, thus, its potential effects on ERP. Findings: The results of the robustness test show that (a) a negative and significant association exists between the turnover ratio of domestic shares to stocks traded and ERP, (b) the increases in stock market competitiveness are associated with increases in the number of listed companies, (c) lowly ranked countries in the MPI are associated with increasing ERP, and (d) in terms of the interaction between duration of stock market development and competitiveness, the relatively competitive stock markets take 2–6 years for stock market development indicators to have a significant effect on ERP. Originality: This paper offers two main contributions to the related literature. The first contribution is to offer a measure of stock market competitiveness using indicators of stock market development. Therefore, robust indicators of stock market development can be reached. The second contribution is to offer empirical results about the length of time (referred to in this paper as duration) required for the indicators of stock market development to have a favorable effect on ERP.