The Case of the Missing Market: The Bond Market and Why it Matters for Financial Development

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may PREFACEThe ADB Institute aims to explore the most appropriate development paradigms for Asia composed of well-balanced combinations of the roles of markets, institutions, and governments in the post-crisis period.Under this broad research project on development paradigms, the ADB Institute Working Paper Series will contribute to disseminating works-in-progress as a building block of the project and will invite comments and questions.I trust that this series will provoke constructive discussions among policymakers as well as researchers about where Asian economies should go from the last crisis and current recovery. ABSTRACTAlthough the growing literature on the importance of finance in economic growth contrasts bank-based financial systems with market-based financial systems, little attention has been paid to the role of the bond market. Correspondingly the role of the bond market has been very small relative to that of the banking system or equity markets in most Asian emerging economies. We argue that the underdevelopment of Asian bond markets has undermined the efficiency of these economies and made them significantly more vulnerable to financial crises.We begin by describing the role of financial markets and institutions in economic development.We show that the underdevelopment of capital markets limits risk-pooling and risk-sharing opportunities for both households and firms. The weak financial infrastructures that characterize many Asian economies are shown to inhibit the development of bond markets relative to equity markets.The consequences of operating a financial system with a banking sector and equity market, but without a well-functioning bond market are profound and far ranging. Without a market-determined interest rate, firms will lack a true measure of the opportunity cost of capital and will invest inefficiently. Opportunities for hedging financial risks will be constrained. Savers will have less attractive portfolio investment choices and, consequently, fewer savings may be mobilized by the financial system to fund investment. Firms may face a higher effective cost of funds and their investment policies may be biased in favor of short-term assets and away from entrepreneurial ventures. Firms may take excessive foreign exchange risks in an attempt to compensate for the lack of domestic bond markets by borrowing abroad. In addition, the banking sector will be larger than it would otherwise be. Since...

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