Innovation, Institutions and Three Dimensions of Financial Structure

TL;DR

This study analyzes how innovation influences stock markets and banking sectors across 75 countries, revealing that innovation boosts stock market activity, efficiency, and size, with effects moderated by institutional quality and technological proximity.

Contribution

It provides a comprehensive cross-country analysis of the differential impacts of innovation on financial market dimensions, considering institutional and technological factors.

Findings

Innovation increases stock market activity, efficiency, and size.

Institutional quality moderates the impact of innovation in complex ways.

The effect of innovation on activity persists over time.

Abstract

This paper studies the response of stock markets relative to the banking sector to innovation by using a panel of 75 countries from 1982 to 2021. We find that innovation increases the activity, efficiency and size of stock markets relative to the banking sector, moderated by proximity to technological frontier and institutional quality. The moderating effect of institutional quality is positive for activity and efficiency but negative for size. Moreover, the moderating effect can be nonlinear depending on specific indicators. The marginal effect of innovation on the activity is persistent over many years, but the moderating effect of institutional quality gradually fades away.