Economic Analysis and International Law
Chapter 4: Financial markets: bonds, stocks, and politically-connected firms
As emphasized by Bai and Ng (2006: 829) in their conclusive study on the issue, "asset prices are forward-looking and market-driven." They thus represent good barometers for evaluating the cost of corruption from the investors' perspective. Ng recalls a number of previous empirical studies which examine the effects of corruption on financial markets and which we recap in the following. In greater detail, Ciocchini et al. (2003) look at bond spread as a proxy for borrowing cost, whilst Fishman et al. (1991) and Lee and Ng (2006) examine stock market valuation. When it comes to borrowing costs, Ciocchini et al. (2003) and, then, drawing heavily on that study, Ng (2006) show that corruption increases borrowing costs for governments and firms in emerging markets. They focus on the role of corruption in determining the price of emerging market bonds sold on the global bond market. Ciocchini et al. (2003) use the launch spreads of these bonds, i.e. the spread between the initial yield of these bonds and the rate commanded by a risk-free bond of the same maturity. The spread of these bonds reflects the higher default probability associated with emerging market debt. As Ng (2006: 829) remarks, "they are in effect studying the relationship between corruption and the perceived likelihood that a firm or government will default on its debt."
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