Financial Development and Asymmetric Information

Angelos A. Antzoulatos*
antzoul@unipi.gr
(210) 414-2185

Chris Tsoumas
ctsoum@unipi.gr
(210) 414-2155

Dimitris Kyriazis
dkyr@unipi.gr
(210) 414-2464

Department of Banking & Financial Management

University of Piraeus
80 Karaoli & Dimitriou street
Piraeus 18534, Greece

Abstract.
We test the hypothesis that the degree of asymmetric information should decrease as
financial systems develop, in a panel co-integration framework with annual data for 32
countries. To this end, we extend Barron et al.s (1998) model to derive a measure of
analysts consensus that takes into account biases and herding in their forecasts. We
calculate this measure, which is negatively related to asymmetric information, at the
country level, with data from the I/B/E/S Global Aggregates database. In addition, we
proxy financial development with the extensive set of indices found in the Word Banks
Financial Development and Structure database. Consistent with expectations, and
despite the substantial differences across countries in terms of financial development
and the quality of the institutional framework, the measure of analysts consensus is
positively related to indices proxying for the development of the financial system.
JEL Classification Numbers: D82, G14, G20
Keywords: Asymmetric Information, Analysts Forecasts, Financial Development
___________
* Corresponding author. We thank Charles Calomiris, Martin Gruber, Gikas Hardouvelis, Gregory
Koutmos, Roman Krussl, Dimitris Malliaropoulos, Chris Pantzalis, Nikitas Pittis, George Skiadopoulos,
Ekaterini Panopoulou and seminar participants at the 63rd International Atlantic Economic Conference,
Madrid, March 2007, the 11th International Conference on Macroeconomic Analysis, Crete, Greece, May
2007, the 5th Infinity Conference on International Finance, Dublin, June 2007 and the University of
Piraeus, for several insightful comments on an earlier version of this paper. The usual disclaimer applies.

Electronic copy available at: http://ssrn.com/abstract=981725

Financial Development and Asymmetric Information

Abstract.

We test the hypothesis that the degree of asymmetric information should decrease as
financial systems develop, in a panel co-integration framework with annual data for 32
countries. To this end, we extend Barron et al.s (1998) model to derive a measure of
analysts consensus that takes into account biases and herding in their forecasts. We
calculate this measure, which is negatively related to asymmetric information, at the
country level, with data from the I/B/E/S Global Aggregates database. In addition, we
proxy financial development with the extensive set of indices found in the Word Banks
Financial Development and Structure database. Consistent with expectations, and
despite the substantial differences across countries in terms of financial development
and the quality of the institutional framework, the measure of analysts consensus is
positively related to indices proxying for the development of the financial system.

JEL Classification Numbers: D82, G14, G20

Keywords: Asymmetric Information, Analysts Forecasts, Financial Development

Electronic copy available at: http://ssrn.com/abstract=981725

1. Introduction.
In this paper, we explore the well-developed but, to the best of our knowledge, not
tested so far hypothesis that the degree of asymmetric information should decrease as
financial systems develop and move towards the capital-market based norm as
opposed to the bank-based one. In short, the need for public information, which is
crucial for the assessment of firms prospects and, hence, for giving them the external
funds they need in order to realize these prospects, is higher in capital-market based
financial systems than in bank-based ones. In the latter, the private information banks
acquire thanks to their close relationships with the borrowing firms, together with
banks higher bargaining leverage vis--vis these firms as compared to the leverage of
bond-holders and minority shareholders, attenuate this need. For more details, the
interested reader may refer to Beim and Calomiris (2001, pp. 150-192) and Mishkin
(2000, pp. 181-198). For a more robust theoretical framework, the reader may refer to
Diamond (1984).
Without doubt, the lack of relevant empirical work owes much to the difficulty
of quantifying the degree of asymmetric information and of financial development, both
of which are qualitative and multi-faceted. For example, to construct an index for the
degree of asymmetric information, it is not sufficient to take into account the
regulations concerning the quality, quantity and timeliness of information disclosed by
firms. Additionally, one has to take into account the incentives for compliance and the
quality of law enforcement. Indeed, not a simple task!
To overcome this difficulty, we combine two branches of the literature, finance
and growth and corporate finance. The first proposes several proxies for financial
development, the second for asymmetric information. Levine (2004) provides an
excellent survey of the former, Clarke and Shastri (2001) a comprehensive list and a

neat taxonomy of the latter. Clarke and Shastri additionally discuss the theoretical
ambiguity concerning the relationship of most asymmetric information proxies with
asymmetric information, that is, whether it is positive or negative.
Compared to the existing literature, we use a more extensive set of financial
development indices, while our asymmetric information measure has more robust
theoretical foundations. Starting with the second, from the asymmetric information
proxies used so far, we work with the dispersion of analysts earnings forecasts,
perhaps, the most widely used proxy and with the strongest theoretical background.
Barry and Brown (1985) show that analysts beliefs about firms earnings tend to
converge as the amount of public information increases. Barry and Jennings (1992)
confirm this theoretical conclusion, even though they show that the effect of private
information on analysts diversity of opinion depends on the relative amounts of private
and public information in the market.
However, Barron et al. (1998) (henceforth BOSD) show that analysts consensus
is a better proxy of asymmetric information. This proxy, defined as the ratio of common
among analysts uncertainty to overall uncertainty, is negatively related with asymmetric
information. As BOSD show, it can be calculated from the observed statistics of their
forecasts. Botosan and Harris (2000), Barron et al. (2002) and Liang (2003) are among
those who have used this proxy.
To make a long story short, our testable hypothesis is that the consensus in
analysts forecasts should be positively related with indices that measure the
development of the financial system. Yet, in practice, analysts forecasts, and the
measure of consensus derived from them, is contaminated by several weaknesses that
potentially affect its relationship with the financial development proxies. These
weaknesses pertain to the conflicting incentives analysts face, rational biases, cognitive

biases and herding (see, for example, Antia and Pantzalis, 2006; Cooper et al., 2001;
Friesen and Weller, 2006; Lim, 2001).
However, by extending BOSDs model, we show that the testable hypothesis
still holds. Briefly, we postulate that analysts produce their forecasts in two stages. In
the first, they perform a signal-extraction exercise that reflects the properties of their
information environment, as in BOSD. In the second, they adjust their first-stage
unbiased forecasts based on the aforementioned weaknesses. Each analyst knows his
first-stage forecasts, while the other analysts, as well as the investors, observe his
reported second-stage forecasts.
The identifying assumption is that the magnitude of the second-stage
adjustments decreases as asymmetric information decreases. So does their effect on the
consensus of analysts forecasts. Intuitively, more public information reduces analysts
leeway and incentives to report biased forecasts. It also reduces the need for herding
and, perhaps, the potential for cognitive biases.
Graphically, the logical foundations of our work are illustrated in figure 1,
which portrays the structure of the financial system. In this figure, the line segments
AA, BB, CC, DD and EE mark the points where asymmetric information exists. Our
focus is on the point marked by the AA-segment, which corresponds to the first-stage
unbiased forecasts. Yet, owing to the said weaknesses, we essentially measure
asymmetric information at the point marked by the BB-segment, which corresponds to
the reported forecasts. To say it differently, these weaknesses drive a wedge between
what analysts believe and what they report. They also drive a wedge between their
true and the observed consensus.

Figure 1. Financial System Structure and Asymmetric Information

Data Constraint

Our Focus

Direct Financing

Lenders/Savers
Funds

B
E
Funds

Financial Markets
Money Markets
Capital Markets

Funds

Households
Firms
Governments
Non-residents

Borrowers
Firms
Governments
Households
Non-residents

Funds

A
C

Financial Intermediaries

Banks
Other Financial Institutions
Other

Indirect Financing

Funds

To make a long story short, there are three influences on the consensus in
analysts forecasts: one from the true asymmetric information, the second from
herding, and the third from analysts conflicting incentives and the rational biases. All
these influences are positively related to asymmetric information. But they affect
analysts consensus differently: The first and the third negatively, the second positively.
The overall effect, although unknown a priori, is likely to be negative. Nevertheless, as
discussed in the concluding section, this ambiguity about the overall effect does not
diminish the importance of our results. In short, if the results are significant with the
noisy measure of consensus used here, they should be stronger with the true one.
As for the financial development proxies, we use the extensive set of indices
found in the Word Banks Financial Development and Structure database (Beck et al.,
2000), in an effort to capture as many aspects of financial system structure and
development as possible. These indices measure the size, activity and efficiency of the
various segments of the financial system, i.e., of financial intermediaries, the insurance

industry and of the stock and bond markets, in a consistent across countries and across
time way. For the econometric analysis, we employ a panel co-integration framework,
with annual data for 32 countries, for the period 1990-2004. The sample is dictated by
data availability.
The econometric results are consistent with expectations. Briefly, analysts
consensus is positively related with private credit by banks and other financial
intermediaries, as well as with the development of the life insurance industry and the
liquidity of the stock market. Higher values for these three indices are indicative of
more developed financial systems. In addition, the results are reinforced by several
robustness checks.
To the best of our knowledge, this is the first paper that attempts to empirically
examine the relationship between financial development and asymmetric information. A
related paper by Chang et al. (2000) has a more limited scope. It links asymmetric
information at the country level, proxied with the dispersion in analysts forecasts, and
in a cross-sectional setting, with observable country characteristics, such as, average
firm size, stock market capitalization over GDP, legal origin, and an index measuring
the quality of disclosure standards. In tune with the results of this paper, it finds that,
ceteris paribus, an Anglo-Saxon legal system, which presumably is more conducive to
the development of capital markets, is associated with lower dispersion.
Relative to Chang et al. (2000), the value-added of this paper stems from several
factors. To begin with, we use a more robust measure of asymmetric information. In
addition, some of the observable characteristics, such as, legal origin and quality of
disclosure standards, are not always good indicators of the level of financial
development. As several knowledgeable observers have noted, there may exist countries
with the same set of characteristics but different financial systems, for factors, such as,

politics and historical experience, have shaped their systems (Rajan and Zingales,
2003). In addition, using these characteristics, which do not vary very much over time,
in a cross-sectional setting, one cannot explore the joint evolution of the financial
systems and asymmetric information as is done here. Last but not least, the panel cointegration technique employed here takes into account the influence of Chang et al.s
largely time-invariable characteristics.
The remainder of the paper is organized as follows. Section 2 presents the
theoretical model that formalizes the testable hypothesis, while Section 3 discusses the
proxies for financial development. Section 4 presents the data and analyzes the
econometric issues related to unit-root testing and co-integration in a panel setting,
while Section 5 presents the empirical results. Section 6 concludes.

2. Analysts Forecasts and Asymmetric Information.

We extend BOSDs model to relate the properties of analysts information environment

with the observed statistics of their forecasts, while taking into account the weaknesses
of these forecasts. As already noted, these weaknesses, i.e., the conflicting incentives
analysts face, their rational biases, cognitive biases and herding, drive a wedge between
what analysts believe line segment AA in figure 1 and what they report line
segment BB.
To facilitate the discussion, we begin with a brief outline of BOSDs setting.
They consider a firm followed by N analysts who forecast firms earnings y. Each
analysts information set has two subsets, one containing common information available
to all, the other private information. The forecasts that are based on common
information have mean y and precision (inverse of variance) h, while the forecasts that

are based on analyst i's private information are denoted as zi = y + i, where the
stochastic term i is a signal observed only by analyst i. This term, which denotes that
private information differs across analysts, is independent of the other variables and
follows a normal distribution with zero mean and precision si. The higher the si, the
more accurate the analysts i forecast of firms earnings.
While y and h are in the public domain, i and si are not. Investors and other
analysts know of the existence of the private signals but not their properties.
Nevertheless, an increase in the precision h of public information relative to total, that is
an increase in

h
, denotes a decrease in the degree of asymmetric information
h + si

between firm managers and analysts. Each analysts forecast is his best estimate based
on available information, as shown in equation (1).

i E[ y | z i ] =

hy + s i z i
h + si

(1)

BOSD define consensus, denoted as , as the ratio of common uncertainty, denoted as

C, to overall uncertainty, denoted as V.

C
V

(2)

Common uncertainty is the average pair-wise covariance among analysts forecasts.

Overall uncertainty is the average across analysts expected variance of y, conditional on
their information set.
As they prove in their Appendix B, can be expressed as

= 1

N 1

(3)

where
1

1
h
,
i = hV , ai =

N
h +s i
i =1

Vi V

V
i =1
N

and Vi E ( y i ) =
2

1
.
h + si

BOSD note that encompasses the effect of both the presence of asymmetric
information, measured through , and the differential quality of private information,
measured through . Moreover, they show that consensus, , and overall uncertainty, V,
are functions of the dispersion of analysts forecasts, D, the standard error in the mean
forecast, SE, and the number of analysts N.
To examine the relation between consensus and asymmetric information, we
transform equation (3) into

1
N 1

(4)

where is the variance of is around their mean, (for this and all subsequent proofs
see the Appendix).
Differentiating equation (4) with respect to , gives

1
1 a
= 1+

N 1 2 N 1 a2

(5)

Equation (5) provides the logical foundations of our work. Consensus increases as
increases, that is, as asymmetric information decreases. Algebraically,

>0

(6)

To see it, the first two terms in equation (5) are strictly positive. For the third term, there
are three cases: 1) it is zero when is independent of , / = 0, 2) positive when is
negatively related to , / < 0, and 3) negative when is positively related to ,
/ > 0. Only the third of the above cases may result to a decrease in as increases.
But it is logical to assume that as the degree of asymmetric information decreases, that
is, as increases, the differential quality of private information across analysts,
expressed with , should not increase. All in all, most likely consensus is an
increasing function of ,

> 0, and thus, a decreasing function of asymmetric

information.
Next, we extend BOSDs model to take into account the effect of analysts
conflicting incentives, rational biases and herding on the observed statistics of their
forecasts. To do so, we assume that each analyst does not report his best estimate of a
firms earnings, i, but a biased one, i*, given by equation (7).

i* E[ y | z i ] + u i =

hy + si z i
1
+ u i = i + u i where ui ~ N(i, )
h + si
i

(7)

To facilitate the comparison with BOSDs results, we denote the variables of the
extended model with the same letter as in their paper plus an asterisk (*). Any cognitive

10

biases are subsumed into i and we do not consider them any further. Yet, under the
assumption that the cognitive biases do not increase as asymmetric information
decreases, the conclusions are not affected.
The term ui in equation (7) accounts for the aforementioned weaknesses in
analyst i's forecasts. The weaknesses can vary across analysts. Yet, higher |i| and 1/i
denote bigger weaknesses and bigger bias in the forecasts. We further postulate that ui is
not correlated with the unbiased forecast of analyst i, that is Cov(ui, i) = 0.
Our identifying assumption is that the magnitude of these weaknesses is
positively associated with asymmetric information. To say it differently, as the precision
of public information h relative to total increases, that is, as ai =

h
increases, the
h + si

leeway of analysts to report biased forecasts because of the conflicting incentives they
face decreases. So do their leeway and incentive to report rationally biased forecasts, as
well as their need for herding. In terms of the statistical properties of ui, as the degree of
asymmetric information between firms managers and analysts decreases, |i| and 1/i
are expected to decrease as well.
Investors observe the mean across analysts forecast *

1
=

i =1

and the dispersion in forecasts d *

*
i

(
i =1

hy + si z i
+ ui ) = + u
h + si

(8)

1 N
( i* - * ) 2 .
N 1 i =1

Since, by construction E ( i* * ) = 0, the unconditional expectation of d*, which

is the dispersion of the biased forecasts observed by investors, is

11

D * E[d ] =

1 N
Var ( i* * )
N 1 i =1

(9)

The uncertainty of investors regarding firms earnings related to analyst is forecast i* ,

is the expected variance of y conditional on analysts i biased forecast

V i* Var ( y i* ) = V i +

1
i

(10)

The overall level of uncertainty of investors is the average across analysts uncertainty

V*

1
N

Vi = V +
*

i =1

1
N

i =1

(11)

Comparing equations (10) and (11) with the corresponding equations in BOSD, the
incremental effect of the weaknesses is reflected on the terms

and

1
N

i =1

, both of

which are expected to decrease as the degree of asymmetric information decreases. At

the limit, when there is no bias in the forecasts,

= 0 and V* of our extended model

will be equal to V of BOSDs model.

The average pair-wise covariance among analysts biased forecasts, given in
equation (12),

1 N *
1 N 1 N
C Ci = C +
Cov(ui , u j )

N i =1
N i =1 N 1 j i

(12)

12

is equal to that in BOSD, C, plus the term

1
N

N-1
i =1

Cov(u i ,u j ) .

j i
N

The terms Cov(ui,uj) capture herding by analysts. Thus, they are positive. In
addition, according to our identifying assumption, they are expected to decrease as the
degree of asymmetric information decreases.
The standard error in the mean forecast, SE* , is

[(

SE * = E y *
= SE +

1
N2

)]
2

i =1

+ 2 +

1
N2

Cov (u , u
i

i =1 j i

(13)

where SE is the standard error of the unbiased forecasts.

Analogously to BOSD, we define consensus * as

* =

C*
.
V*

Substituting equations (11) and (12) in this expression, it turns out that

* =

1+ B

A
1+ B

(14)

where

A=

1
N

1 N

Cov(u i , u j )

i =1 N 1 j i
>0
V
N

and

B=

1
N

i =1

> 0.

13

A is related to herding, B to all weaknesses in analysts forecasts. According to our

identifying assumption, both A and B are positively related to asymmetric information,
A
<0
a

and

B
< 0,
a

and, hence, expected to decrease as financial systems develop. Also, in terms of figure
1, the line segment AA is associated with , while the line segment BB with *.
Differentiating equation (14) with respect to gives

A
B
( + A)
*

= +

(1 + B ) (1 + B )
(1 + B )2

(15)

The three terms on the right hand side of equation (15) capture the three influences of
asymmetric information, measured through , on the consensus of the biased forecasts,
*. The first is negative see equation (6) above. The second and the third are negative
and positive respectively, since

A
B
< 0 and
< 0.
a
a

All in all, even though the effect of an increase in asymmetric information on the
observed analysts consensus is not certain, it is likely negative.

*
<0

(16)

However, this ambiguity does not undermine the logical foundations of the
empirical work. Consider the case that the second term in equation (16) is relatively
large. This would obscure the effect of the first term, which is of our primary interest.
Yet, if the noisy consensus at the line segment BB turns out to be significantly and

14

positively related to the indices measuring financial development, then the latters true
effect at the line segment AA should be even stronger than that indicated by the
econometric results.
Lastly, as shown in the Appendix, * and V* are functions of the SE*, D* and N.

* =

SE *

D*
N

1
(1 ) D * + SE *
N

V * = (1

1 *
) D + SE *
N

(17)

(18)

In the empirical analysis we use equations (17) and (18) to calculate consensus * and
uncertainty V*, using the observable statistics of analysts biased forecasts, i.e.,
dispersion, D*, standard error, SE*, and the number of analysts, N.

3. Proxies for Financial Development.

Ideally, to measure financial development, one should quantify how well financial
systems accomplish their functions, i.e., the mobilization of savings, the easing of
exchange of goods and services, the ex ante production of information about
investments and the allocation of capital, the ex post monitoring and the exertion of
control of realized investments, the facilitation of trading, and the diversification and
management of risk (Levine, 2004). However, this is easier said than done, for the
majority of these functions are qualitative in nature. In addition, financial systems may
accomplish their functions equally efficiently under different structures. To overcome
this objective difficulty, several indices have been used in the literature. They fall into
15

two broad categories: Those attempting to measure financial development through the
observed outcomes, and those attempting to do so through characteristics of the
institutional environment.
Among the studies using indices falling into the first category, King and Levine
(1993) use liquid liabilities to GDP as a measure of the size of financial intermediaries,
credit to private enterprises to GDP as an activity measure, and the ratio of bank assets
to the sum of bank assets plus central bank assets. Demetriades and Hussein (1996)
measure financial development with the ratio of money to GDP. Alternatively, Neusser
and Kugler (1998) use the value-added of the financial system instead of simple
measures of its size. Rousseau and Wachtel (1998), and Levine et al. (2000) use
measures that include the assets of both banks and non-banks, such as private credit to
GDP from banks and non-deposit money banks. Levine and Zervos (1998), and Arestis
et al. (2001) add measures of stock market size and liquidity to bank development
measures. Last but not least, Beck et al. (2001) include measures of life insurance and
private pension fund assets.
The studies using indices falling into the second category follow the seminal
work of La Porta et al. (1997). Specifically, La Porta et al. show that a countrys legal
tradition and quality of law enforcement affect financial development and structure, for
financial decisions are based on contracts and laws. In addition, La Porta et al. (2002)
use the degree of public ownership of banks around the world as a proxy for financial
development. The intuition behind this measure is that publicly owned banks are less
efficient than private ones.
We work with indices falling into the first category, for the other indices are
largely time-invariant and, hence, cannot be readily used to explore the time evolution
of the degree of asymmetric information. Nevertheless, our estimation technique, panel

16

estimation with country and time dummies, captures the effect of the time-invariant
characteristics of the institutional environment.
Yet, Benhabib and Spiegel (2000) raise a serious concern. Most of the studies in
the first category use a limited set of indices that are related to specific segments of the
financial system and, therefore, are unlikely to capture all aspects of its structure and
development. Moreover, noting that these indices are correlated with the largely
unobservable country characteristics, like those identified in the studies in the second
category, they point out that the interpretation of their econometric results suffers from
an omitted variables bias.
With the aim to address Benhabib and Spiegels concern to the extent possible,
we use the extensive set of indices in the World Banks Financial Development and
Structure database (Beck et al., 2000). They measure, in a consistent across countries
and time way, the development of the main sectors of the financial system, namely,
banks and other financial intermediaries, the insurance industry, the stock market, the
private and public bond markets.
Table 1 summarizes the twelve indices used. The first column reports the
symbol used, the second provides a short description and the third further details. The
indices are organized in four groups, each group corresponding to a major segment of
the financial system: five indices, denoted as FIi (i=1,5), measuring the size and activity
of banks and other financial intermediaries, as well as the efficiency and structure of the
banking sector; two indices, denoted as INSi (i=1,2), measuring the development of the
insurance industry; three indices, denoted as SMi (i=1,3), measuring the size, liquidity
and depth of the stock market; and two indices, denoted as BMi (i=1,2), measuring the
size of the private and public bond markets.

17

Insert Table 1 here

To save space, more details will be discussed in the empirical section for the indices
that are statistically significant.

4. Empirical Issues.

4.1 Consensus Measures.

We use data from the I/B/E/S Global Aggregates database to construct the consensus
and uncertainty measures, * (equation (17)) and V* (equation (18)). This database
provides the weighted average standard deviation of analysts earnings per share
(henceforth EPS) forecasts, the mean earnings per share forecasts, the realized EPS, the
total number of estimates and the number of companies with a mean EPS forecast for
stock-market indexes both at the country and industry levels. For a country index, these
variables are the weighted averages of the relevant variables for the indexs constituent
companies. They are measured using the countrys national currency (for details, see
I/B/E/S Global Aggregates Reference Guide 2). For each available index, I/B/E/S
Global Aggregates reports the relevant data for fiscal years 1 and 2, where fiscal year 1
(henceforth FY1) corresponds to forecasts for the current calendar year and fiscal year 2
(henceforth FY2) for the next.
As in Botosan and Harris (2000), Barron et al. (2002) and Liang (2003), the
dispersion in analysts forecasts D* is calculated as the square of the weighted average
standard deviation of analysts EPS forecasts (see equation (9)), while the standard error
SE* is calculated using equation (13). In these calculations, y and * are the weighed

18

average realized EPS and mean forecast respectively. Finally, the number of analysts N
for each fiscal year is proxied by the ratio of the number of forecasts for each index
divided by the number of companies.
Thus, we construct consensus and uncertainty measures for the calendarized FYi
period i (i=1,2), for the FTSE (denoted *iFTSE and V*iFTSE respectively) and MSCI
(denoted *iMSCI and V*iMSCI respectively) indexes for each country. The I/B/E/S data are
available from 1987 for many countries. However, due to data availability constraints,
the sample period is restricted to 1990-2004. The data frequency is annual, dictated by
the financial development data availability. The consensus and uncertainty measures are
calculated on a monthly basis and then are averaged over the 12-month forecast period
which begins in March and ends next February. Using the 12-month averages reduces
the level of high-frequency noise and, additionally, overcomes the difficulty of which
month of a forecast year to choose.
The FTSE index includes 22 countries, most of which are OECD members:
Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany,
Ireland, Italy, Japan, Mexico, Netherlands, New Zealand, Norway, South Africa, Spain,
Sweden, Switzerland, U.K. and U.S.A. The MSCI index includes 32 countries: the
above, excluding Brazil, plus Chile, Greece, India, Indonesia, Korea, Pakistan, Peru,
Philippines, Poland, Portugal and Turkey.

4.2 Descriptive Statistics.

Table 2 provides summary statistics for the dependent variables, i.e., the four consensus
and the four uncertainty measures. The columns correspond to the variables, the rows to
the sample countries. Each cell reports the sample mean (over time). The last two

19

couples of rows report the average and standard deviation across countries of the
country means, the first for the whole sample and the second without the three outliers
for the uncertainty measures, Brazil, Mexico and Turkey.
As Table 2 indicates, the consensus measures exhibit cross-country variation
that is slightly larger for the FTSE than the MSCI index for both FY1 and FY2.
Specifically, the ratio of the standard deviation to the average for FY1 is 0.17
(=0.072/0.425) for the FTSE and 0.22 (=0.088/0.401) for the MSCI index, while the
relevant figures for FY2 are 0.19 and 0.21 respectively. As for the uncertainty measures,
the respective ratio is in the order of four or higher (first of the aforementioned two
couples of rows). Removing the three large outliers brings this ratio down to a little over
one for the FTSE index and over two for the MSCI index. Note, however, that the
results of the empirical analysis are virtually the same with or without these countries.

Insert Table 2 here

4.3 Econometric Issues.

We test a joint hypothesis: First, the degree of asymmetric information is negatively

related to financial development. Second, analysts leeway and incentives to report
biased forecasts, as well as the need for herding, decrease as asymmetric information
decreases. To test this hypothesis, we estimate equation (21) using panel co-integration
techniques.

20

Ykt = +

j =1

j IPFjkt +
j =1
j =1
j =1
+ j CONTROLjkt 1 + k + t + u kt

j FI jkt +

j SM jkt +

j BM jkt +

(21)

FIjkt denotes the financial intermediaries index j, for country k, at year t. Similarly, the
SMjkt, BMjkt and IPFjkt denote the indices for the stock market, the bond markt and the
insurance industry.
This is a fixed effects model with country intercepts, k, and time dummies, t.
The country intercepts capture country-specific factors that are time-invariant, such as,
factors pertaining to the institutional environment. The time dummies capture shocks
that are common to all countries.
To control for macroeconomic uncertainty and market risk, we include in
equation (21) as control variables, denoted as CONTROL, the real GDP growth rate,
inflation measured with the CPI, and the within-the-year standard deviation of
inflation and of the monthly returns of the total market return index (dividends
included). In terms of the theoretical model, the control variables are associated with the
lower precision of common information h, and herding behavior. The control variables
are measured at t-1 because, as previously mentioned, the consensus and the uncertainty
measures are averaged over the period from March of each year to February of the
subsequent year. However, the results are virtually the same when the control variables
are dated at t. Lastly, to overcome scaling problems of the four uncertainty measures,
owing mainly to that the I/B/E/S forecasts are in national currencies, we take the
logarithms of the V* measures.
All variables in the above equation were tested for common unit roots in a panel
framework, using the Breitungs t-stat and Hadris z-stat. The former employs a null

21

hypothesis of a unit root, and is preferred relative to the Levin, Lin and Chu test, as
having substantially higher power (Baltagi, 2005, p. 243). The later uses a null of no
unit root, being analogous to the Kwiatkowski, Phillips, Schmidt, and Shin (KPSS) test
in the time series framework. A variable is characterized as I(1) when at least one test
gives this indication. With the exception of the real GDP growth rate, all variables were
found to be I(1). To save space, the results of the panel unit root tests are not reported
here but are available upon request.
To estimate the long-run (co-integrating) relationship between the I(1) variables
in equation (21), we use the panel Dynamic OLS (DOLS) estimator. As is well known,
DOLS uses a parametric approach to deal with serial correlation, and is more
appropriate than the Fully Modified OLS (Baltagi, 2005, p.258). Using the Schwarz
criterion, we choose the appropriate number of leads and lags for the I(1) independent
variables. Additionally, we use the cross-section SUR (Panel Corrected Standard Errors
- PCSE) standard errors and covariance method, corrected for degrees of freedom, to
deal

with

possible

cross-sectional

heteroskedasticity

and

cross-sectional

contemporaneous correlation. Finally, the residuals of equation (1) were tested for unit
roots, using the aforementioned panel unit root tests, and were found stationary,
indicating the presence of panel co-integration among the statistically significant I(1)
variables.
Additionally, we estimate the relevant panel error-correction models for both
analyses, where the differences of only the statistically significant I(1) variables are
used, together with the error-correction term of the relevant panel co-integrating
equations.

22

5. Results.

Tables 3 and 4 summarize the empirical results of the panel co-integrating equations.
The first presents the results for the consensus and the second for uncertainty, for the
FTSE index in Panel A and the MSCI index in Panel B. The two tables have the same
structure: The first row shows the dependent variable, while the other rows report the
estimated coefficients (t-statistics in parentheses) of the statistically significant
regressors, the adjusted R2 and the Durbin Watson statistic.
In summary, the results are consistent with expectations. There is a long-run
relationship between the consensus (Table 3) and uncertainty measures (Table 4) with
indices that measure the activity of financial intermediaries, the efficiency of the
banking segment, as well as the development of the insurance industry and the stock
and bond markets.

5.1 Consensus.

Specifically, consensus is positively related with the index measuring the development
of private credit by banks and other financial intermediaries in all cases, i.e., for the
FTSE and the MSCI index and forecast horizons FY1 and FY2. This index is similar to
that in Rousseau and Wachtel (1998) and Levine et al. (2000). The positive relationship
is consistent with the hypothesis that financial development is associated with lower
asymmetric information, as well as with Diamonds (1984) theoretical argument that
well functioning financial intermediaries minimize informational asymmetries between
suppliers and users of funds. Indeed, the long-run relationship between this variable and
asymmetric information proxy indicates that as banks and other financial intermediaries

23

expand private credit, valuable public information diffuses in the economy about firms
prospects and profitability and thus, asymmetric information decreases. In addition,
lower asymmetric information facilitates the expansion of private credit.

Insert Table 3 here

In greater detail, as Panel A in Table 3 documents, the consensus for the FTSE index
and fiscal year 1, *1FTSE, forms a panel co-integrating vector with the private credit by
banks and other financial intermediaries, the stock market liquidity and public bond
market size (indices FI2, SM2 and BM2 respectively) for FY1. The consensus for the
same index for fiscal year 2 forms a panel co-integrating vector with FY2 only.
The signs of the estimated coefficients are reasonable and interesting.
Specifically, the positive coefficient of the FI2 index in the equations for *1FTSE and
*2FTSE (coefficients/t-statistics: 0.21/1.85 and 0.36/4.13 respectively) indicate that as
private credit by banks and other financial intermediaries increases, the consensus in
analysts EPS forecasts for both forecast horizons also increases, and, hence,
asymmetric information decreases. The positive coefficient of the SM2 index
(coefficient/t-statistic: 0.15/3.03) shows that the liquidity of the stock market is positive
related to consensus, and thus, negatively to asymmetric information. The negative
coefficient of the BM2 index (coefficient/t-statistic: -0.62/-2.89) indicates that the
development of the public bond market is positively associated with asymmetric
information. Leaving aside institutional barriers for the development of private bond
markets in repressed and less-developed financial systems, this indicates that in markets
with high informational asymmetry and uncertainty investors prefer government bonds
over private bonds.

24

Panel B in Table 3 reports the relevant results for the MSCI index. *1MSCI and
*2MSCI are positively associated with private credit (coefficients/t-statistics 0.22/3.05
and 0.32/3.67) In addition, *1MSCI is positively associated with the development of life
insurance (coefficients/t-statistics 3.38/2.20), while *2MSCI with banks overhead costs
(index FI3), and inflation (INF) (coefficients/t-statistics 4.37/2.05 and 0.01/1.86). INS1s
positive sign is related to the fact that life insurance companies are themselves financial
intermediaries, which are engaged on relationship lending and, thus, complement banks
as informational agents. The sign of FI3 cannot be readily explained. The positive sign
of INF probably indicates that the EPS have an inflationary component. Intuitively,
firms earnings consist of two parts, one related to inflation and the other to firms real
activitydeflated earnings. High inflation, which is easier to forecast than deflated
earnings, may lead to increased precision of public information h.

5.2 Uncertainty.

As table 4 documents, uncertainty is positively related with the index measuring banks
overhead costs. Large overhead costs reflect cost inefficiency (Levine et al., 2007).
They are also associated with small banks that do not have substantial income from feebased activities and/or operate in a restrictive environment (Demirguc-Kunt et al.,
2004). Thus, the results indicate that a less developed and/or less efficient banking
segment is related to higher uncertainty. Reasonable, indeed!

Insert Table 4 here

25

In greater detail, banks overhead costs (index FI3) are significant in almost all cases,
that is for both FTSE and MSCI indexes and for the two forecast horizons, FY1 and FY2.
This result indicates that the (in)efficiency of the banking sector is associated with
lower precision of information and/or higher biases.
Other financial development indices, such as INS1, INS2, SM2 and SM3 enter the
co-integrating vectors of the uncertainty measures, however in a non-systematic way.
From these, only SM2 has a negative sign, indicating that high stock market liquidity is
related to lower asymmetric information. Finally, market risk (index MKTRISK) is
significant for both, FTSE and MSCI indexes for the longer forecast horizon FY2,
indicating that higher market volatility is associated with greater analyst uncertainty.
Lastly, in the relevant error-correction models for the asymmetric information
and the uncertainty measures, the error-correction term is significant at the 1% level in
all cases, with negative sign as expected. To save space, the results are not reported but
are available upon request.
Several robustness checks provide further support to the papers thesis, for their
results were essentially the same with the above. Specifically, we repeated the analysis
without the countries that experienced crises during the period under examination, i.e.,
Brazil, Indonesia, Japan, Mexico, Philippines and Turkey, for crises may have exerted
singular influence on the explanatory variables. Additionally, we lagged once the
financial development indices in the right-hand-side of equation (19), we also used their
lead values and performed the econometric analysis for various sub-samples of
countries. Lastly, we experimented with another asymmetric information proxy that has
been used in the literature and which is readily available at the country level, namely,
the open interest of the futures contracts on the FTSE and MSCI indexes for each
country, as percentage of total contracts traded.

26

6. Concluding Remarks.

By combining two branches of the literature, i.e., corporate finance and finance and
growth, this paper makes a significant we believe contribution towards empirically
examining the relationship between financial development and asymmetric information.
The results provide strong evidence that the degree of asymmetric information
decreases as financial systems develop. Perhaps, what is astonishing is the significance
of the results, despite the substantial differences in the structure and development of the
financial systems of the sample countries, and the use of noisy proxies for asymmetric
information. Worth also noticing is that the results, taken literally, suggest that the
development and the efficient operation of financial intermediaries seem to have been
among the key determinants of the reduction in asymmetric information in the sample
countries over the 15-year period under examination.
A few remarks are in order. We use a measure of analysts consensus which is
negatively related to asymmetric information. This measure, in addition to uncertainty
about the prospects of firms owing both to asymmetric information and business risk,
encompasses several weaknesses of the forecasts themselves, namely, rational biases,
cognitive biases, herding, and analysts conflicting incentives. The data does not allow
us to evaluate how financial development has affected genuine asymmetric information
and the various biases in the sample countries over the sample period. Nevertheless, the
results unambiguously suggest that as financial systems develop the consensus in
analysts forecasts increases, which, in turn, provides strong evidence that asymmetric
information decreases.

27

And this is good for investors. As financial systems develop, investors can put
more faith in analysts forecasts. This, however, does not imply that they should not
make their own research. Moral hazard is ever present. That is, as financial systems
develop, investors may perceive that the value of information gathering and analysis
decrease and, as a result, the free-rider problem may get exacerbated.
Closing, the results suggest two lines for further research. First, a re-examination
of the evidence from cross-sectional analysis that use analysts forecasts. For example,
Diecther et al. (2002) find evidence that stocks with higher dispersion earn lower future
returns than otherwise similar stocks. Lim (2001) documents the existence of rational
forecast bias that is larger for companies for which the problem of asymmetric
information is bigger and for analysts who rely more on access to the firms management
for information (such access presumably attenuates the asymmetric information
problem). Halov (2006), who uses the dispersion of analysts forecasts at different
horizons as a proxy for current and future asymmetric information, finds evidence
consistent with the hypothesis that firms try to minimize inter-temporally the adverse
selection cost, which is positively related with asymmetric information, when issuing
securities. Under the assumption that financial systems develop as time goes by, we
expect that the effect of asymmetric information will progressively decrease.
Finally, the results call for a re-thinking of policy issues related to financial
regulation. Perhaps, common rules, while appealing for their cross-country conformity,
may not be optimal. Basle II, for example, may prove to be too much of a straightjacket. If, as comes out from this paper, the degree of asymmetric information differs
and likely changes at different speed across countries, its Pillar III may not be equally
effective in all of them. What are its implications needs to be explored.

28

Appendix.

Proof of equation (4).

1

N
1
= 2
V

Vi V

V
i =1
N

1
1

N
i =1 h + s i
N

1 1
= 2 2
h V N

1 1
2 N

i =1 h + s i

h
1

N
i =1 h + s i
N

(
i =1

i =1 h + s i

2
)

So,

29

2

= 1

1
N

2
)
i =1

1
( - 1)

1
( - 1)

1
=
( - 1)
= +

i =1
N

i =1

2 i + 2

N
N
2
i +
i

N ( N 1) i =1
N ( N 1)
i =1
N

2
N
1

( N 1) N ( N 1) ( - 1)

N
1

N -1
( - 1)

i =1

i =1

2
i

2
i

Let i = + k i
Then

k i = 0 and
i =1

Thus

1
N

k
i =1

2
i

= , where is variance of is.

i =1

i =1

i 2 = 2 + 2 k i + k i 2 = N 2 + k i 2 = N 2 + N

Finally, substituting this last expression into ,

N
1
1

N 1
N 1
N ( N 1)

k
i =1

2
i

1
N 1

30

Proof of equation (10).

Let i* = i + ui, where ui ~ N(i,

1
) , Cov(y-i, ui) = 0.
i

Then,
Vi Var ( y i* )
*

= E (( y i* )-E ( y- i* )) 2

= E (( y i u i ) E ( y i u i )) 2

= E (( y i )-u i E ( y i ) + E (u i )) 2

= E (( y i )-u i + E (u i )) 2

= E ( y i ) 2 + E (u i2 ) + ( E (u i )) 2 2 [( y i )u i ] + 2 ( y i ) E (u i ) 2 E [u i E (u i )]

= Vi + E (u i2 ) + ( E (u i )) 2 2Cov ( y i ,u i ) 2 E ( y i ) E (u i ) + 2 ( y i ) E (u i ) 2( E (u i )) 2

= Vi + E (u i2 ) ( E (u i )) 2

= Vi + Var (u i ) + ( E (u i )) 2 ( E (u i )) 2

= Vi +

1
i

31

Proof of equation (12).

Assuming that Cov(y-i, uj) = 0 i, j,

C*

1
N

Ci*
i =1

N 1

N 1

Cov( y i u i , y j u j )

j i

1
N

1
N

1
N

1
N

N 1
i =1

1
N

N 1
i =1

i =1

i =1

i =1

N 1

Cov( y i* , y *j )

j i
N

j i

[Cov( y i , y j ) Cov(ui ,y j ) Cov( y i , u j ) + Cov(ui ,u j )

h ( y y ) s h( y y ) s j j
i i
Cov
,

h
s
h+ sj
+
i
j i

1
N

N -1
i =1

=C+

j i

1
h
+
(h + s i )(h + s j ) N

N -1
i =1

1
+
N

N -1
i =1

j i

Cov(ui , u j )

Cov(u i , u j )

j i
N

Cov(u i , u j )

j i
N

32

Proof of equation (13).

Let u =

1
N

1
N

ui and =
i =1

i =1

It is

Var (u ) = Var (

1
N

ui ) =
i =1

N
1
1
Var
(
ui ) = 2

2
N
N
i =1

Cov(u u
i =1 j =1

i,

Thus,

[(

SE * = E y *

)]
2

2

ui

i =1

1
= E y
N

[
]
= [( y ) ] 2 E [( y )u ] + E (u
= E ( y ) 2( y )u + u 2
2

= SE 2 E (u ) E ( y ) + Var (u ) + (E (u ) )
= SE +

= SE +

= SE +

1
N2
1
N2
1
N2

Cov(u , u
i

i =1 j =1
N

Var (ui ) +
i =1
N

i =1

+ 2 +

)+2

1 N N
Cov(ui , u j ) + 2
N 2 i =1 j i
1
N2

Cov(u , u
i =1 j i

33

Proof of equations (17) and (18).

Let ei* y i* for i = 1, K , N .

Then,
D* =

1 N
1
Var (ei*
N 1 i =1
N

e*j )

(N-1 )N 2

Var ( Nei*

i =1

e*j )
j =1

i =1

i j

j =1

Var ( (ei* e *j ))
2
(N-1 )N
N

1
2

( N 1) N

i =1

1
( N 1) N 2

[( N 1) 2 Vi*

j i

Cov(ei* , e *j ) +

j i

Cov(ei* , e*j )]
j i k i , j

Cov(ei* , e*j )]

i =1

( N 1) 2

[( N 1) 2 Vi * + ( N 1)Vi* + {2( N 1) + ( N 2)}

j i

N 1

i =1

j i

V* +
V* +
[( N ) Cov(ei* , e *j )]
2 i
2 i
2
( N 1) N
( N 1) N
( N 1) N
i =1

V j* 2( N 1)

N -1 1
(
N N

i =1

Vi* ) +

i =1

1 1
(
N N

i =1

Vi* )

1
N

i =1

1 N
Cov(ei* , e *j )
N 1 j i

= V * -C *
= V * (1 * )

34

In turn, let e * = y * and ei = y i

*

Then,

1
SE * = Var
N
1
= Var
N

e
i =1

*
i

(y
i =1

*
i

1
N
*
Var
( y i )

2
N
i =1

N N
1 N
*
*
V
Cov (ei , e j )
+

2 i
N i =1
i =1 j i

1 * N 1 *
V +
C
N
N

V * + NC * C *
=
N
= C* +

D*
N

D*
=V +
N
*

Solving the system of the D* and SE* equations, gives equations (17) and (18) in the
main text.

35

References.

Antia, M., Pantzalis, C., 2006. Security analyst incentives and quality of analyst
generated information. The Journal of Investing, Spring.
Arestis, P., Demetriades, P.O., Luintel, K.B., 2001. Financial development and
economic growth: The role of stock markets. Journal of Money, Credit and
Banking 33, 16-41.
Baltagi, B.H., 2005. Econometric Analysis of Panel Data. John Wiley & Sons, Ltd, 3rd
Edition.
Barron, O.E., Oliver, K., Steve, C.L., Douglas, E.S., 1998. Using analysts forecasts to
measure properties of analysts information environment. The Accounting Review
73, 421-433.
Barron, O.E., Byard, D., Kile, C., Riedl, E., 2002. High technology intangibles and
analysts forecasts. Journal of Accounting Research 40, 289-312.
Barry, C.B., Brown, S.J., 1985. Differential information and security market
equilibrium. Journal of Financial and Quantitative Analysis 20, 407-422.
Barry, C., Jennings, R., 1992. Information and diversity of analyst opinion. Journal of
Financial and Quantitative Analysis 27, 169-183.
Beck, T., Demirg-Kunt, A., Levine, R., 2001. The financial structure database, In:
Demirg-Kunt, A., Levine, R. (Eds.), Financial Structure and Economic Growth:
A Cross-Country Comparison of Banks, Markets, and Development. MIT Press,
Cambridge, MA, pp. 17-80.
Beck, T., Demirg-Kunt, A., Levine, R., 2000. A new database on financial
development and structure. World Bank Economic Review 14, 597-605.
Benhabib, J., Spiegel, M.M., 2000. The role of financial development in growth and
investment. Journal of Economic Growth 5, 341-360.

36

Beim, D.O., Calomiris, C.W., 2001. Emerging Financial Markets. Mc-Graw-Hill

Irwin, New York.
Botosan, C.A., Harris, M.S., 2000. Motivations for a change in disclosure frequency and
its consequences: An examination of voluntary quarterly segment disclosures.
Journal of Accounting Research 38, 329-353.
Chang, J. J., Khanna, T., Palepu, K., 2000. Analyst activity around the world.
Unpublished working paper. Harvard Business School.
Clarke, J., Shastri, K., 2001. On information asymmetry metrics. Unpublished working
paper, University of Pittsburgh.
Cooper, R. A., Day, T.E., Lewis, C.M., 2001. Following the leader: A study of
individual analysts earnings forecasts. Journal of Financial Economics 61, 383416.
Demetriades, P., Hussein, K., 1996. Does financial development cause economic
growth? Time series evidence from 16 countries. Journal of Development
Economics 51, 387-411.
Demirguc-Kunt, A, Laeven, L., Levine, R., 2004. Regulations, market structure,
institutions and the cost of financial intermediation. Journal of Money, Credit and
Banking 36, 593-622.
Diamond, D.W., 1984. Financial intermediation and delegated monitoring. Review of
Economic Studies 51, 393-414.
Friesen, G., Weller, P.A., 2006. Quantifying cognitive biases in analyst earnings
forecasts. Journal of Financial Markets 9, 333-365.
Halov, N., 2006. Dynamics of Asymmetric Information and Capital Structure.
Unpublished working paper. New York University.
I/B/E/S Global Aggregates Reference Guide, Issue 2. Thomson Financial Limited.

37

King, R. G., Levine, R., 1993. Finance and growth: Schumpeter might be right.
Quarterly Journal of Economics 108, 717-738.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 1997. Legal determinants of
external finance. Journal of Finance 72, 1131-1150.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., 2002. Government ownership of
commercial banks. Journal of Finance 57, 265-301.
Levine, R, 2004. Finance and growth: Theory and evidence. NBER working paper No.
10766.
Levine, R., Barth, J., Caprio, G., 2007. The microeconomic effects of different
approaches to bank supervision. In Haber, S., North, D., Weingast B. (Eds.), The
Politics of Financial Development. Stanford University Press.
Levine, R., Loayza, N., Beck, T., 2000. Financial intermediation and growth: Causality
and causes. Journal of Monetary Economics 46, 31-77.
Levine, R., Zervos, S., 1998. Stock markets, banks, and economic growth. American
Economic Review 88, 537-558.
Liang, L. 2003. Post-earnings announcement drift and market participants information
processing biases. Review of Accounting Studies 8, 321-345.
Lim, T., 2001. Rationality and analysts forecast bias. Journal of Finance 56, 369-385.
Mishkin, F. S., 2000. The Economics of Money, Banking and Financial Markets.
Addison, Wesley, Longman, New York.
Neusser, K., Kugler, M., 1998. Manufacturing growth and financial development:
Evidence from OECD countries. Review of Economics and Statistics 80, 636-646.
Rajan, R., Zingales, L., 2003. The great reversals: The politics of financial development
in the twentieth century. Journal of Financial Economics 69, 5-50.

38

Rousseau, P.L., Wachtel, P., 1998. Financial intermediation and economic performance:
Historical evidence from five industrial countries. Journal of Money, Credit and
Banking 30, 657-678.

39

Table 1. Financial Development Indices

Index

Definition

FI1

Deposit money bank assets to GDP

Claims on domestic real non-financial sector by

deposit money banks as a share of GDP

FI2

Private credit by deposit money

banks and other financial
institutions to GDP

Private credit by deposit money banks and other

financial institutions to GDP

FI3

Banks overhead costs

Accounting value of a bank's overhead costs as a

share of its total assets.

FI4

Banks net interest margin

Accounting value of bank's net interest revenue as

a share of its interest-bearing (total earning) assets.

FI5

Banks concentration

Assets of three largest banks as a share of assets of

all commercial banks in the system

INS1

Life insurance penetration

Life insurance premium volume as a share of GDP

INS2

Non-life insurance penetration

Non-life insurance premium volume as a share of

GDP

SM1

Stock market capitalization to

GDP

Value of listed shares to GDP

SM2

Stock market total value traded to

GDP

Total shares traded on the stock market exchange

to GDP.

SM3

Stock market turnover ratio

Ratio of the value of total shares traded and

average real market capitalization

BM1

Private bond market capitalization

to GDP

Private domestic debt securities issued by financial

institutions and corporations as a share of GDP

BM2

Public bond market capitalization

to GDP

Public domestic debt securities issued by

government as a share of GDP

Source: Financial Development and Structure database, World Bank.

40

Table 2. Descriptive Statistics Sample Means of the Dependent Variables

*1FTSE

*2FTSE

*1MSCI

*2MSCI

V*1FTSE

V*2FTSE

V*1MSCI

V*2MSCI

Australia

0.349

0.547

0.342

0.565

2.84

8.60

16.77

54.27

Austria

0.428

0.533

0.433

0.510

8.68

33.08

66.99

187.78

Belgium

0.373

0.478

0.332

0.503

7.20

20.45

86.54

256.29

Brazil

0.394

0.471

4,713.24

5,825.69

Canada

0.436

0.624

0.417

0.568

5.33

18.90

63.61

222.19

0.307

0.442

1,412.20

3,033.94

Denmark

0.477

0.484

0.425

0.497

53.65

84.93

770.85

1,356.85

Finland

0.480

0.562

0.484

0.598

72.86

128.05

67.67

121.44

France

0.494

0.683

0.535

0.713

13.49

36.07

239.21

642.89

Germany

0.370

0.526

0.317

0.510

6.94

20.63

38.98

112.87

Greece

0.321

0.348

186.98

538.82

India

0.458

0.425

5,942.61

6,640.20

Indonesia

0.299

0.584

3.98

11.12

Ireland

0.518

0.758

0.538

0.640

25.20

60.96

27.87

70.06

Italy

0.393

0.546

0.393

0.467

5.21

11.71

184.89

407.94

Japan

0.573

0.684

0.542

0.699

2.09

4.34

159.49

353.19

Korea

0.328

0.578

29.15

84.13

Mexico

0.351

0.489

0.406

0.423

231,174.30

507,400.60

17,678.44

43,007.12

Netherlands

0.493

0.695

0.511

0.681

17.25

49.75

122.26

325.81

New Zealand

0.515

0.665

0.496

0.669

1.87

3.54

5.57

10.76

Norway

0.457

0.615

0.434

0.618

95.65

171.19

2,060.95

2,988.11

Pakistan

0.138

0.253

21.25

40.00

Peru

0.343

0.393

59.19

121.29

Phillipines

0.472

0.635

71.63

221.90

Poland

0.421

0.633

1,154.64

3,008.13

Portugal

0.358

0.411

83.41

11.12

South Africa

0.275

0.298

0.354

0.459

28.98

73.32

13.76

32.44

Spain

0.322

0.428

0.307

0.436

49.99

86.18

66.13

198.61

Sweden

0.403

0.678

0.407

0.615

62.00

239.18

4,365.41

15,795.06

Switzerland

0.414

0.492

0.452

0.544

14.37

30.61

78.66

190.15

0.355

0.396

U.K.

0.411

0.600

0.439

0.612

9.28

27.85

267.70

733.44

U.S.A.

0.422

0.617

0.454

0.622

2.06

13.30

10.73

66.55

Average

0.425

0.567

0.401

0.533

10,744.20

23,379.50

4,063,604.92

5,690,026.39

St.Deviation

0.072

0.107

0.088

0.112

49,243.88

108,114.63

22,980,769.00 32,172,898.51

Average*

24.25

56.13

589.30

1,261.24

St.Deviation*

27.55

61.48

1,344.36

3,089.78

Chile

Turkey

130,000,000.00 182,000,000.00

Notes:
1. Time averages for each variable for each country.

41

2.

3.

4.
5.

Sample period: 1990-2004, except for:

FTSE indexes:
*iFSTE and V*iFSTE: Beginning year 1993 for Mexico, 1995 for Brazil
MSCI indexes:
*iMSCI and V* iMSCI : Beginning year 1992 for Indonesia and Portugal, 1993 for Mexico,
1994 for South Africa, 1995 for Chile, Greece, India, Pakistan, Peru and Turkey, 1996 for
Poland
Variable definitions and Raw Data sources:
*iFSTE and *iMSCI (i=1,2): Analysts consensus about the EPS forecast for the calendarized FYi
fiscal period for the respective index for each country. Source: I/B/E/S Global Aggregates and
authors calculations.
V*iFSTE and V* iMSCI (i=1,2): Analysts uncertainty about the EPS for the calendarized FYi fiscal
period for the respective index for each country. Source: I/B/E/S Global Aggregates and authors
calculations.
The last two couples rows of the Table report the average and standard deviation of each variable
across countries. The first couple includes all countries, the second couple excludes the big outliers
Brazil, Mexico and Turkey.
Sources: I/B/E/S Global Aggregates and authors calculations.

42

Table 3. Panel Co-integrating Equation Analysts Consensus

7

*kt = +

j FI jkt +

j =1

j SM

jkt

j =1

j =1

j BM

jkt

IPF + Control
j

j =1

Panel A. FTSE Index

jkt

jkt 1

+ k + t + u kt

Panel B. MSCI Index

*1FTSE

*2FTSE

*1MSCI

* 2MSCI

Constant

0.40
(2.11)**

0.21
(2.54)***

0.09
(1.02)

0.07
(0.64)

FI2

0.21
(1.85)**

0.36
(4.13)***

0.22
(3.05)***

0.32
(3.67)***
4.37
(2.05)**

FI3
3.38
(2.20)**

INS1
SM2

0.15
(3.03)***

BM2

-0.62
(-2.89)***
0.01
(1.86)**

INF
Adj. R2

0.35

0.25

0.21

0.32

D.W.

2.15

1.69

1.85

1.65

Notes:
1. Estimation technique: Panel Dynamic OLS.
2. Sample period: 1990-2004.
3. Sample countries:
FTSE index (22 countries): Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland,
France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, New Zealand, Norway, South
Africa, Spain, Sweden, Switzerland, UK, US.
MSCI index (32 countries): All the above excluding Brazil, plus Chile, Greece, India,
Indonesia, Korea, Pakistan, Peru, Philippines, Poland, Portugal and Turkey.
4. The Table reports the statistically significant I(1) variables (t-statistics in parentheses) in the
DOLS equation. In all cases the cross-section SUR (PCSE) standard errors and covariance (d.f.
corrected) method was used.
5. Variable definitions:
*iFSTE and *iMSCI (i=1,2): Analysts consensus for the EPS forecast for the calendarized
FYi fiscal period for the respective index for each country
FI2: Private credit by deposit money banks and other financial institutions to GDP
FI3: Banks overhead costs
INS1: Life insurance premium volume as a share of GDP
SM2: Stock market total value traded to GDP
BM2: Public bond market capitalization to GDP
INF: Change in CPI, end of period
6. One (*), (**) and three (***) asterisks denote significance at respectively the 10%, 5% and 1%
level.
7. Sources: I/B/E/S Global Aggregates, World Banks Financial Development and Structure
Database, Datastream and authors calculations.

43

Table 4. Panel Co-integrating Equation Analysts Uncertainty

7

V *kt = +

j FI jkt +

j =1

j SM jkt +

j =1

j =1

j BM jkt +

IPF + Control
j

j =1

Panel A. FTSE Index

Constant

jkt

jkt 1 + k

+ t + ukt

Panel B. MSCI Index

V1FTSE

V2FTSE

V1MSCI

V2MSCI

5.50
(4.07)***

3.38
(2.53)***

8.22
(7.73)***

11.83
(7.78)***

0.60
(2.19)**

0.98
(3.27)***

0.99
(3.29)***

FI3

1.37
(4.41)***

INS1
INS2

0.95
(2.62)***

SM2

-0.46
(-1.77)*

SM3

0.54
(1.87)**

0.29
(2.02)**
0.68
(3.60)***

STDINF
1.35
(3.23)***

MKTRISK

0.64
(2.59)***
1.18
(3.50)***

Adj. R2

0.87

0.91

0.89

0.88

D.W.

1.65

1.58

1.49

1.60

Notes:
1. Estimation technique: Panel Dynamic OLS.
2. Sample period: 1990-2004.
3. Sample countries:
FTSE index (22 countries): Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland,
France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, New Zealand, Norway, South
Africa, Spain, Sweden, Switzerland, UK, US.
MSCI index (32 countries): All the above excluding Brazil, plus Chile, Greece, India,
Indonesia, Korea, Pakistan, Peru, Philippines, Poland, Portugal and Turkey.
4. The Table reports the statistically significant I(1) variables (t-statistics in parentheses) in the
DOLS equation. In all cases the cross-section SUR (PCSE) standard errors and covariance (d.f.
corrected) method was used. All variables are in logarithms.
5. Variable definitions:
V*iFSTE and V*iMSCI (i=1,2): Analysts uncertainty for the EPS for the calendarized FYi
fiscal period for the respective index for each country
FI3: Banks overhead costs
INS1: Life insurance premium volume as a share of GDP
INS2: Non-life insurance premium volume as a share of GDP
SM2: Stock market total value traded to GDP
SM3: Stock market turnover ratio
STDINF: Standard deviation of change in CPI, rolling 12-month periods
MKTRISK: Standard deviation of returns of the total market return index (dividends
included) for each country, rolling 12-month periods

44

6.
7.

One (*), (**) and three (***) asterisks denote significance at respectively the 10%, 5% and 1%
level.
Sources: I/B/E/S Global Aggregates, World Banks Financial Development and Structure
Database, Datastream and authors calculations.

45