SIFR Research Report Series, Institute for Financial Research
City Size and Financial Development
Abstract: Stock markets tend to be few in each country, often
unique, and located in the largest cities. Typically, much of the economic
activity relating to the stock market takes places in this large city.
These facts suggest that agglomeration economies are important. In other
words, productivity is enhanced for stock market-workers and -firms located
in a large city. After discussing this prima facie evidence of
agglomeration economies, we consider the cross-country implications.
Countries with larger cities will have better developed stock markets
because they can benefit from stronger agglomeration economies surrounding
the stock market. This provides an economic theory of financial development
which is complementary to the standard legal and political theories of
financial development. We establish that city size is a robust determinant
of stock market size and activity, but not of other types of financial
development (banks). We show that this is not driven by reverse causality
and that it is not driven by small or new stock markets. Finally, we show
that alternative measures of a country's geography, such as urbanization
and the population of the second largest city, do not predict stock market
development, implying that we do not capture some alternative geographic
effect. We conclude that there is a significant positive effect of city
size on stock market development, that this reflects agglomeration
economies. This explains why countries with large cities have better
developed stock markets.
Keywords: City size; agglomeration economies; financial development; (follow links to similar papers)
JEL-Codes: G10; G20; O16; R10; (follow links to similar papers)
28 pages, September 15, 2006
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