Xin (Kelly) Liu and Shang-Jin Wei. Forthcoming in the Journal of Financial and Quantitative Analysis
The opening of equity markets to foreign investment appears to generate an enormously large positive growth effect (see Bekaert, Harvey, and Lundblad, 2005) in spite of a relatively small role of such markets for financing investment in most economies. We propose a possible spillover channel from equity market opening to lower costs of bank loans, which helps to explain this puzzle. From analyzing bank loan data associated with China’s introduction of the Qualified Foreign Institutional Investors (QFII) program, we find significant support for this channel. Furthermore, we show that a reduction in the risk premium is an important mechanism.