Impact of Capital Market Opening on Systemic Financial Risks: An Empirical Study Based on Transnational Panel Data

Abstract

The 20th CPC National Congress emphasized the importance of adopting a proactive strategy for opening up, aiming to establish a broader, more extensive, and deeper pattern of international engagement. This strategy necessitates enhancing the synergistic effects between domestic and international markets and resources through steady institutional openness. However, the opening of capital markets is accompanied by frequent cross-border capital flows, risking imbalances and increased volatility in local markets. Understanding the risk evolution under such openness can empower China to advance its initiatives from a stronger position, safeguard against systemic financial risks, and ultimately achieve high-quality economic development.

Using data from 38 countries from 2004 to 2019, this paper empirically analyzes the static and dynamic impacts of capital market liberalization, including both inflows and outflows, on systemic financial risks in open countries. The analysis uses the capital market opening index from the GKAOPEN database. The findings indicate that overall capital market opening significantly heightens systemic financial risks. A detailed analysis reveals asymmetrical effects: the opening of capital inflows intensifies financial volatility and increases the likelihood of financial crises. The impact of opening to capital outflows on financial stability varies, depending on the balance between economic gains from compliant investments and the risks associated with capital flight, making the overall influence on financial risk less clear. Even after robustness tests using financial crises and comprehensive financial risk as substitutes for measuring systemic financial risks and controlling for potential endogenous problems, the conclusions remain consistent. Further analysis shows that the impact of capital market opening on systemic financial risk exhibits significant time-varying characteristics. Excessive capital inflows pose a notable risk to open countries.

This paper expands in two key aspects. First, compared to previous literature, such as quasi-natural experiments related to the “Shanghai-Hong Kong Stock Connect” and “Shenzhen-Hong Kong Stock Connect”, it offers novel insights by leveraging continuous time variables from the GKAOPEN database to comprehensively evaluate the impact of various opening-up policies and subdivide the opening direction. Second, recognizing the dynamic nature of opening, this paper goes beyond analyzing the aggregate static impact of opening on risks by empirically focusing on the dynamic influence of capital market opening on financial risk.

Drawing from international experiences of transitioning from emerging to mature markets, capital market opening is crucial for promoting value investment. It encourages competition among financial institutions, supporting high-quality development in the capital market. However, it may also accelerate the cross-border transmission and linkage of risks, leading to increased shared risk exposure between domestic and international markets and concentrating substantial risks in the financial and economic sectors of open countries. Understanding the dynamic evolution of risks during the opening process helps regulatory authorities improve systemic risk monitoring, enhance macro-prudential supervision, and balance development and security in opening up, thereby preventing systemic financial risks.