General Characteristics of Developing Country Capital Markets and Asymmetry Related Allocation Problems

This paper examines developing country capital markets. In particular, the shortcomings of developing country capital markets relative to developed capital markets are discussed. These deficiencies include factors such as illiquidity, lack of long term debt markets, crowding out of the private sector from the publicly traded debt markets, illiquidity derivatives markets that hinder hedging of interest rate and exchange rate exposure of firms. It is argued that all these factors introduce distortions and asymmetries in the capital allocation mechanism by raising the cost of both debt and equity and resulting in an underinvestment problem for these markets. Additionally, the potential impact of the spread of “equity culture” for developing country capital markets and their economies is analyzed.