Institutional quality and stock market performance in emerging economies

Abstract

Rising scholarly and policy interest in the role of institutions in shaping financial markets provides the motivation for this study. The paper examines the impact of institutional quality on stock market performance across a panel of emerging economies covering the period 2000 to 2024. Strong institutions are expected to reduce uncertainty, strengthen investor confidence, improve market transparency, and enhance the efficiency of financial markets. To investigate this relationship, the study employs a dynamic panel estimation framework based on the Generalized Method of Moments (GMM), which effectively addresses issues of endogeneity, reverse causality, and unobserved country-specific effects. Institutional quality is measured using key governance indicators, including control of corruption, government effectiveness, political stability, regulatory quality, and rule of law, while stock market performance is proxied by market capitalization as a percentage of GDP. The empirical results reveal limited persistence in stock market development, as the lagged dependent variable is not statistically significant. Findings from the one-step GMM model show positive but statistically insignificant effects of institutional quality on stock market performance. In contrast, the two-step difference GMM results provide stronger evidence that control of corruption, regulatory quality, and rule of law exert significant positive effects on stock market development. The study concludes that strengthening governance structures, improving regulatory effectiveness, and reinforcing legal institutions are critical for promoting sustainable stock market growth and deepening financial sector development in emerging economies.