Economic Freedom, Financial Crisis and Stock Volatilities in Emerging Markets

Abstract

This paper explores how equity market volatilities are related with the Index of Economic Freedom for 22 emerging countries over 1995-2010 by considering the impacts of financial crisis. Consistent with theory, we find the overall economic freedom index and its components exert significant impacts on equity market volatilities. Specifically, the index components within the categories of regulatory efficiency (such as business freedom and monetary freedom) and limited government (fiscal freedom, and government spending) exhibit strong and significant explaining powers to the stock market volatilities. However, the other index components within the categories of rule of law and open markets are not significant. In addition, the stock market volatilities are significantly higher when the country confronts either one of the currency crisis, inflation crisis, stock market crash, debt crisis, or banking crisis. The results are consistent across different levels of inflation and wealth in emerging markets.

Keywords: Economic Freedom, Financial Crisis, Stock Volatility, Emerging Markets

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