Do Strong Institutions really Combat the Bitterness of Corruption? A Study of BRIC Stock Returns.

<p>Most literature examining the macroeconomic effects of corruption on economic growth, lacks scrutiny of channels of micro foundations for stock markets, which are primary sources of finance in economic development. We contribute to that literature by assessing how corruption and other institutional channels can weaken both supply and demand sides of markets for goods and services in BRIC economies by increasing the cost of inputs to firms and lowering the price received by producers. These elements in effect reduce profit margins of firms and lower returns on equities at micro level. Using panel data regression model and extreme bound analyses, we estimate the effects of corruption and other institutional variables on equity returns in BRIC countries during 1995-2014. While corruption has moderately harmful effects in smooth functioning of stock markets and lowers returns by up to 3 percent in BRIC countries, the degree of democracy and political instability did not have significant effects on stock returns. There is significant co-movement of BRIC returns with global and emerging markets. They relate negatively with global indices and positively with emerging market indices indicating opportunities for diversification despite weak institutions.</p>