Trade Opening and the Behavior of Emerging Stock Market Prices

Trade Opening and the Behavior of Emerging Stock Market Prices

In this paper we develop a model that explores the effect of trade openness on stock price behavior. The model predicts that stock returns show non-zero serial correlation in a closed economy. However, once the country opens on the trade front, the stock returns show zero serial correlation. The reason for the difference is that once the country opens itself to trade, the growth process becomes selfsustained due to optimal use of imported intermediate inputs. Stock prices reflect this gain in productive efficiency by displaying a random walk behavior. The model also establishes that financial opening alone without trade opening will not lead to gain in efficiency in the stock prices.