Do Democracies Attract Portfolio Investment?

X. Cao; M.D. Ward
Journal Article , 2013
Latent attractors in Portfolios

For many, transnational capital is an important driving force of economic globalization. However, we know little about the political determinants for cross-border portfolio investments. Recent economic literature focuses upon information asymmetries. We move beyond this and intro- duce an explicitly political element into the study of international asset flows. Democratic institutions attract portfolio investments because they reduce the chances of predatory practices. Moreover, under real-world time constraints, investors are likely to use democracy as an important information short-cut for more credible property rights protection because the same underlying conditions (individual voice and rights, constraints on the executive, and rule of law) that make an established democracy also guarantee a credible property rights protection from the government. Applying a dynamic latent space model on the bilateral portfolio investment data from 2001 to 2005, we empirically examine the effects of important country-level characteristics of both net exporters and importers of portfolio investments. The empirical findings suggest that democracies are associated with higher levels of inward portfolio investments. We also find that portfolio investments are associated with business communities’ subjective estimate of property rights protection, but not with more comprehensive, index-based aggregate measures from international think tanks. This seems to suggest that investors do not have time to thoroughly study each country’s property rights system but rather rely on their subjective estimates, lending support to the democracy as information short-cut story in this paper.