Democracy and stock market development: The case of Nigeria.

Abstract

Institutional economics theories stress the importance of political dispensations as a determinant of financial market development. The Literature shows that political institutions can influence financial market system by imposing constrains on the discretion of political power. In addition, a more democratic system may encourage free market and increase the number of new entrants which helps existing firms to be more efficient and improves its performance in the stock market. Democracy can reduce the power of government to manage and control the financial market which in turn increases the level of competition and further improves participation. However, the empirical findings remain inconclusive. There is evidence of positive, negative and/or no direct effect of democracy on financial markets. This paper contributes to this debate by examining the dynamic non-linear effect of democracy on stock market development for the period of 1984-2015 within nonlinear ARDL framework. The results show an asymmetric response of stock market to democracy in Nigeria. In a more specific, it shows that stock market’s response to democracy is negative both in the short run and long run. This finding serves as a confirmation that the stock market behaviors are related in a nonlinear way to the institutional fundamentals. The study therefore suggests that weaknesses in governance system, mismanagement of the economy and failure to grant independence to monetary authority are the key sources of challenges facing Nigerian stock exchange market. Efficiency of stock exchange is anchored largely on the efficient institutional environment. A good institutional framework remains the efficient ways of tackling corruption which has been one of the key factors most investors are afraid of in the context of Nigerian capital market. Sound regulation quality with adequate respect for the rule of law, avoid violence and political instability are very important to ensure efficient operation of Nigerian capital market.