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Financial Development and Genetic Diversity
Financial Development and Genetic Diversity Eric Cardella, Ivalina Kalcheva, and Danjue Shang* March 30, 2015 Abstract It is well documented that there is substantial variation in the level of financial development across countries, which research has been trying to explain. In this paper, we investigate how a deep-rooted characteristic – a country’s degree of genetic diversity – impacts the level of financial development. We hypothesize that a country’s degree of genetic diversity can impact its level of financial development through two channels: (i) directly through its effect on innovation in the financial sector, and (ii) indirectly through its effect on productivity and the subsequent demand for financial development. Extending the argument put forth by Ashraf and Galor (2013), we predict a hump-shaped relationship between a country’s degree of genetic diversity and its level of financial development. Using data from almost 150 countries, our cross-sectional analysis reveals results that are consistent with our prediction; namely, we observe a significant and robust hump-shaped effect of a country’s degree of genetic diversity on its level of financial development. Further, we show that both average years of schooling and the quality of social infrastructure within a country are positively associated with the level of financial development. Keywords: financial development, genetic diversity JEL classification codes: G1, G2, O1, O4, 05 * Cardella is from Texas Tech University. Kalcheva is from University of California, Riverside and Shang is from University of Arizona. The emails for the authors are [email protected], [email protected], and [email protected]. The authors thank Hank Bessembinder, Laura Cardella, Scott Cederburg, Daniel Folkinshteyn, Rawley Z. Heimer and Feng Yang, as well as seminar participants at the University of Arizona, the 2015 Conference of the Midwest Finance Association, and the 2015 Conference of the Southwestern Finance Association. Abstract It is well documented that there is substantial variation in the level of financial development across countries, which research has been trying to explain. In this paper, we investigate how a deep-rooted characteristic – a country’s degree of genetic diversity – impacts the level of financial development. We hypothesize that a country’s degree of genetic diversity can impact its level of financial development through two channels: (i) directly through its effect on innovation in the financial sector, and (ii) indirectly through its effect on productivity and the subsequent demand for financial development. Extending the argument put forth by Ashraf and Galor (2013), we predict a hump-shaped relationship between a country’s degree of genetic diversity and its level of financial development. Using data from almost 150 countries, our cross-sectional analysis reveals results that are consistent with our prediction; namely, we observe a significant and robust hump-shaped effect of a country’s degree of genetic diversity on its level of financial development. Further, we show that both average years of schooling and the quality of social infrastructure within a country are positively associated with the level of financial development. 1 Introduction There exists a mature and wide-ranging body of literature suggesting, both theoretically and empirically, that a country’s level of development in the financial sector is an important component of its economic growth.1 In particular, a well-developed financial sector can serve many integral functions including: reducing transaction and information costs, pooling and managing risk, allocating resources, mobilizing savings, performing entrepreneurial screening, and facilitating trade. Levine (1997), who provides a discussion of the importance of financial development to growth and surveys the literature, notes: “a growing body of work would push even most skeptics toward the belief that the development of financial markets and institutions is a critical and inextricable part of the growth process.” (p. 689) While the potential advantages of financial development have been identified and empirically documented, there exists substantial heterogeneity in the level of financial development across countries (Beck et al., 2003; Rajan and Zingales, 2003). This has spurred substantial research attention aimed at identifying the possible factors that can affect financial development. The result is a growing body of literature identifying many contributing factors to a country’s level of financial development. These factors include: (i) a country’s level of economic development and the subsequent demand for financial development2 (Rajan and Zingales, 2003; Ang and 1 Examples of papers documenting the importance of financial development include: Greenwood and Jovanovic (1990), Roubini and Sala-i-Martin (1992), King and Levine (1993), Atje and Jovanovic (1993), Pagano (1993), De Gregorio and Guidotti (1995), Jayaratne and Strahan (1996), Rajan and Zingales (1998), Demirgüç-Kunt and Maksimovic (1998), Beck et al. (2000), Beck and Levine (2002), Carlin and Mayer (2003), Aghion et al. (2005), Brown et al. (2009), and Hsu et al. (2014). See also Levine (1997), Rajan and Zingales (2001), Levine (2005), and Zingales (2015) for additional survey-style discussions related to the link between finance development and growth. The idea that financial development spurs economic growth is consistent with the supply side arguments suggested by Schumpeter (1912) and Hicks (1969), where increases in the supply of financial development lead to increases in economic growth. 2 This demand-side story for increased financial development is in line with Robinson’s (1952) argument that “where enterprise leads, finance follows.” 3 McKibbin, 2007), (ii) a country’s level of trade and/or capital openness (Rajan and Zingales, 2003; Chinn and Ito, 2006), (iii) a country’s legal system origin, which is typically classified as common law or civil law (La Porta et al., 1997, 1998; Beck et al., 2003), (iv) a country’s cultural factors (Stulz and Williamson, 2003), and (v) a country’s natural endowment, which is typically characterized by the geographical landscape and/or the disease environment (Acemoglu et al., 2001; Beck et al., 2003). This extant literature is suggestive of the notion that many structural sources can play an important role in shaping the cross-sectional variation in a country’s level of financial development. In this paper, we investigate how a more deep-rooted factor that might play a role in explaining the heterogeneity in the level of financial development across countries – a country’s degree of genetic diversity among its population. Using cross-sectional data from almost 150 countries, we explore if and to what extent a country’s aggregate degree of genetic diversity is associated with its level of financial development. In our analysis, we consider several different proxy measures of financial development, as well as control for other structural factors shown to be associated with financial development as mentioned above. The aim of this paper is to shed light on how country-level genetic diversity can possibly affect an important country-level aggregate outcome – the country’s level of financial development. Recently, a burgeoning field of research has emerged that lies at the intersection of genetics and economics/finance, which focuses on identifying if and to what extent genetic variation can account for differences in individual preferences, economic/financial decision making, and outcomes (see Ebstein et al., 2010; Beauchamp et al., 2011; and Benjamin et al., 2012 for thorough discussions and reviews of the literature). In general, this recent research suggests that genetics can play a role in shaping economic/financial decision making and 4 outcome. For example, genetic variations have been shown to impact individuals’: investment biases (Cronqvist and Siegel, 2014), portfolio allocation choices (Barnea at al., 2010; Cesarini et al., 2010), risk preferences (Cesarini et al., 2009; Zyphur et al., 2009; Kuhnen and Chiao, 2009; Dreber et al., 2009), decision biases (Cesarini et al., 2012), income (Taubman, 1976; Benjamin et al., 2012), cooperative tendencies and pro social behavior (Wallace et al., 2007; Cesarini et al., 2008; Israel et al., 2009). While much of this previous literature has explored the effect of genetic variation at the individual level, we explore the possible aggregate influence of genetic variation at the country level. In doing so, our study complements the recent extant literature related to genetics and economics/finance, as well as contributes more broadly to our understanding of how genetic variation can play a role in shaping important financial outcomes. In measuring a country’s degree of genetic diversity, we borrow the proxy recently developed and used by Ashraf and Galor (2013) (A&G henceforth). Specifically, A&G build on the work of population genetics by Ramachandran et al. (2005) and construct a country-level measure of (predicted) genetic diversity that is based on migratory distance of the country from East Africa. The basic idea behind this measure, as noted by A&G, is that “migratory distance from the cradle of humankind in East Africa had an adverse effect on the degree of genetic diversity within ancient indigenous settlements across the globe” (p. 2). We provide more discussion of genetic diversity and how A&G construct their measure of predicted genetic diversity in Section 3. A&G develop a stylized model where genetic diversity is predicted to have a concave or “hump-shaped” effect on economic development. In particular, as the genetic diversity of a country increases, they postulate that there is a beneficial effect of development from expansion in the production possibilities frontier, which allows for the development and implementation of new technologies. However, they also postulate that too high a degree of 5 genetic diversity can have a disadvantageous effect on development because of coordination problems and mistrust, which lowers cooperation among the population and the ability to produce at the production possibilities frontier. Using cross-sectional, country-level data the authors find empirical support for their model of a hump-shaped effect of a country’s degree of genetic diversity on its (proxied for) level of economic development. Consistent with the arguments posited by A&G, we hypothesize that a country’s degree of genetic diversity can impact its level of financial development. We posit that there are two ways through which genetic diversity can influence financial development. The first is through the direct effect on innovation in the financial sector. In particular, there will be a hump-shaped relation between a country’s level of genetic diversity and innovation in the financial sector, which in turn will impact the level of financial development via the supply of financial development. The second is through its indirect effect on economic development. A&G document a hump-shaped relation between genetic diversity and economic development. As a result, this will lead to a corresponding change in the demand for and, subsequently, the level of financial development in a country. Hence, the degree of genetic diversity in a country can impact its level of financial development through two possible channels: (i) directly through its effect on financial innovation, and (ii) indirectly through its effect on the demand for financial development (working through the effect on economic development). Moreover, the effect of genetic diversity on financial development is hump-shaped through both channels, and, hence, we predict an overall hump-shaped relation between genetic diversity and financial development. To empirically investigate our prediction, we use a cross-sectional analysis for around 150 countries. For each country, we gather data on its level of financial development from the World Bank, a measure of its degree of genetic diversity developed by A&G, as well as other controls. 6 To measure a country’s level of financial development, we use several different proxies that have been employed by previous research studies: (i) market capitalization, (ii) value of stocks traded, (iii) number of stocks listed, and (iv) expropriation risk of foreign investment (Rajan and Zingales, 2003; Beck et al., 2003; and Stulz and Williamson, 2003). As predicted, our cross-sectional analysis in year 2000 CE yields a significant hump-shaped relation between a country’s degree of genetic diversity and the proxy measures of financial development we consider. This result is generally robust even after controlling for other possible factors that may affect financial development including: a country’s openness, legal origin, natural endowment, education level, and social infrastructure. To attempt to separate out the effect of genetic diversity of financial development coming directly through financial innovation, rather than through the demand for financial development, we include a proxy for the demand of financial development (per capital GDP) as an independent control variable. Even after controlling for the demand for financial development, a persistent significant hump-shaped relation between genetic diversity and financial development exists. This is consistent with our prediction that genetic diversity has a hump-shaped effect on financial innovation, which then impacts the level of financial development. Again, these results are robust even after controlling for other established factors that have been shown to impact financial development. Lastly, we show that both the average years of schooling and the quality of social infrastructure are positively associated with a country’s level of financial development. This result points to the important and complex interplay between genetic and environmental factors, i.e., nature and nurture (Coll et al., 2003), in influencing financial development at the county level. We view our study as contributing broadly to the area of research aimed at identifying possible factors that can affect a country’s level of financial development. While much of the 7 previous literature (cited earlier) has focused primarily on the role of structural, institutional, cultural, or political factors in shaping financial development, we take a complementary approach by investigating a more deep-rooted characteristic of a country – its degree of genetic diversity. We document a robust link between a country’s degree of genetic diversity and its level of financial development. Furthermore, we show that the hump-shaped relation between genetic diversity and financial development persists even after controlling for GDP (a proxy for the demand for financial development), which suggests a direct relation between genetic diversity and the supply of financial development via financial innovation. Given the important and inextricable role that financial development plays in economics growth, it is important to understand the factors that affect financial development (Beck et al., 2003); the insights gleaned from this study contribute to this understanding. The remainder of the paper is organized as follows. Section 2 develops the main hypothesis of the paper regarding the effect of genetic diversity on financial development; Section 3 explains the design of our empirical tests, the data, and the construction of the variables we use in the analysis; Sections 4 and 5 present the results; and Section 6 concludes. 2 Hypothesis Development We proceed by motivating the main hypothesis of our study; namely, that a country’s degree of genetic diversity plays a role in shaping its level of financial development. We predict that this effect of genetic diversity will come through two channels: (i) directly, by impacting the level of financial innovation in a country and the subsequent supply of financial development, and (ii) indirectly, by impacting the level of economic development in a country and the subsequent 8 demand for financial development. Our jumping off point is the predictions and empirical findings documented in A&G. In particular, A&G explore the effect of a country’s degree of genetic diversity on its level of economic growth. In doing so, they posit a model where an increase in genetic diversity has both a beneficial and a detrimental effect on economic productivity. With regard to the beneficial effect, they argue that an increase in genetic diversity widens the spectrum of traits across the population. This, in turn, will enable higher levels of productivity through specialization of the labor force, complementarities across these different specialized tasks, and a larger concentration of higher-cognitive ability individuals. As stated by A&G, “higher diversity therefore enhances society’s capability to integrate advanced and more efficient production methods, expanding the economy’s production possibility frontier and conferring the benefits of improved productivity” (p. 3). However, there is a possible detrimental impact on economic development resulting from too high a degree of genetic diversity that arises through decreases in trust and cooperation among the population, which, consequently, decreases the production efficiency of a country relative to its production possibilities frontier. A&G argue that the interplay between the beneficial and detrimental effects of genetic diversity is predicted to result in a hump-shaped relation of genetic diversity and a country’s level of economic development. A&G proceed by documenting robust empirical evidence of this predicted hump-shaped effect of genetic diversity. The first distinct channel through which genetic diversity can impact financial development is financial innovation and the subsequent supply of financial development. We consider financial innovation in a broad sense to represent any new technologies, advancements, and/or improvements in all of the possible functions of the financial sector. As discussed in Frame and White (2004), this includes but is not limited to: new products, new services, new processes, and 9 new organizational forms, each of which facilitate and/or improve the functioning of the financial sector. Both the prevalence and significance of financial innovation, especially during the 20th century, have been extensively recognized (Miller, 1986; Merton, 1992; Allen and Gale, 1994; Tufano, 2003; Frame and White, 2004; Lerner, 2006). Moreover, Lerner (2006) points to the importance of financial innovation within the financial sector as well industries outside the financial sector; similarly, Frame and White (2004) note the direct and indirect benefits of financial innovation. Laeven et al. (2015) explicitly model financial innovation as an important factor that affects economic growth. In their model, financial innovation results from the outcome of profitmaximizing financiers. The authors assert that financial innovation, via advancements and improvements in entrepreneurial screening technologies, plays an important role as it increases the likelihood of investing in the most promising technologies. Furthermore, the authors note that there must be financial innovation, concurrent with technological innovation, to avoid stagnation. Relatedly, Tufano (1989) hypothesizes that there is a first-mover advantage with regard to financial innovation, and documents empirical evidence consistent with this hypothesis. Cardella et al. (2014) assert that the intention to innovate the trading process has been fierce in recent years primarily through the computerization of the trading process. Hence, a benefit is conferred to financial innovators, which serves as a motivation to innovate that is distinct from the abovementioned demand channel. We contend that the argument put forth by A&G regarding the effect of genetic diversity on productivity, applies more specifically to innovation in the financial sector; namely, that the effect of genetic diversity on financial innovation will be hump-shaped. An increase in genetic diversity will have a beneficial effect on financial innovation through the complementarities of 10 more specialized traits and higher concentrations of more innovative thinkers. At the same time, this beneficial effect will be offset by the detrimental effects on financial innovation resulting from mistrust and lower levels of cooperation at high enough levels of genetic diversity. Assuming that the benefits of increased genetic diversity are diminishing (as is assumed in A&G), then a hump-shaped pattern will emerge. As a result, the first channel through which genetic diversity is predicted to impact financial development is through its direct effect on financial innovation and the subsequent supply of financial development. There also exists substantial research highlighting the important link between economic development and financial development. The idea is that as a country becomes more productive, the accompanying increased economic development increases the demand for more developed and well-functioning financial markets/institutions; this increase in demand then fosters financial development. The demand-driven justification for financial development has been proposed conceptually (Robinson, 1952), documented empirically (Luintel and Khan, 1999; Rajan and Zingales, 2003; Ang and McKibbin, 2007), and even suggested anecdotally, e.g., ‘‘the US has also regained its primacy as the world’s leading stock market . . . Underlying these gains is a powerful upsurge in productivity.”3 Combining the link between economic development and financial development (based on increased demand) with the findings of A&G yields the following hypothesis: the degree of genetic diversity impacts a country’s level of productivity and economic development, which in turn will impact the demand for financial development. As a result, the second channel through which genetic diversity is predicted to impact a country’s level of financial development is indirectly through its effect on economic development and the 3 Business Week, October 9, 1995, “Riding high,” by Christopher Farrell, Michael J. Mandel and Joseph Weber. 11 demand for financial development. To summarize, our predictions regarding the relation between a country’s degree of genetic diversity and its level of financial development are as follows: Genetic diversity impacts financial development through two separate channels: (i) directly through its effect on financial innovation, and (ii) indirectly through its effect on the demand for financial development. Genetic diversity has a hump-shaped effect on the level of financial development; namely, low and high levels of genetic diversity will be associated with relatively lower levels of financial development, while intermediate levels of genetic diversity will be associated with relatively higher levels of financial development. 3 Data and Methodology In this section, we begin with a description of the overall empirical methodology, followed by the data and the various financial development measures and other controls we consider, and conclude with summary statistics. 3.1 Methodology Our main hypothesis is that a country’s degree of genetic diversity impacts its level of financial development. To investigate this hypothesis, we employ a country-level, cross-sectional regression analysis. To establish an overall relation between a country’s level of genetic diversity and its financial development (without attempting to separate out the effect coming though each of the two proposed channels), we first regress a country’s level of financial development on its degree of genetic diversity with the following specification: 𝐹𝐷𝑖 = 𝑎0 + 𝑎1 ∙ 𝑔𝑑𝑖 + 𝑎2 ∙ 𝑔𝑑𝑖 2 + 𝜷𝑿𝑖 + 𝜀𝑖 (1) 12 where 𝐹𝐷𝑖 is a given measure of the level of financial development for country i, gdi is the country’s degree of predicted genetic diversity measure, 𝑔𝑑𝑖 2 is the square of its genetic diversity measure, and Xi is a vector of control variables. We include the 𝑔𝑑𝑖 2 term to enable us to test for the possibility of a non-linear effect of genetic diversity on financial development. In particular, if a country’s genetic diversity and its level of financial development has a humpshaped relation, as hypothesized, then we would expect 𝑎1 > 0 and 𝑎2 < 0, both significant. Next, we attempt to examine the effect of the country’s genetic diversity on financial development that is operating directly through financial innovation, as opposed to the composite effect that includes the indirect effect that is operating through the demand for financial development. To do so, we include as an independent control variable a measure of a country’s level of demand for financial development. Specifically, we consider the following specification: 𝐹𝐷𝑖 = 𝑎0 + 𝑎1 ∙ 𝑔𝑑𝑖 + 𝑎2 ∙ 𝑔𝑑𝑖 2 + 𝑎3 ∙ 𝑑𝑖 + 𝜷𝑿𝑖 + 𝜀𝑖 , (2) where 𝐹𝐷𝑖 , gdi, 𝑔𝑑𝑖 2 , and Xi are defined as they were in specification (1), and 𝑑𝑖 is a measure of country i’s level of demand for financial development, which will be proxied for with a measure of economic development.4 If it is the case that there is a direct relation between genetic diversity and financial development coming through financial innovation, and the relationship is humpshaped, then we would expect to continue to see 𝑎1 > 0 and 𝑎2 < 0 and both significant. 3.2 Data We proceed by first explaining what we mean by a country’s level of financial development 4 We acknowledge here that the demand for financial development 𝑑𝑖 , as proxied for by a measure of economic development, is likely to be endogenous to financial development. That said, the motivation of our paper is not to identify a causal link between economic development and financial development. Rather, the motivation for including 𝑑𝑖 is to control for the demand for financial development at the country level in the cross-sectional analysis, allowing us to separate out the relation between genetic diversity and financial development that is not coming through the demand channel. 13 and then by describing the measures we use to proxy for financial development. We then describe the main independent variables we use in the regression analysis, which include: our measure for a country’s degree of genetic diversity (which is adopted from A&G), our proxy for a country’s level of demand for financial development, as well as other control variables that have been shown in previous studies to explain cross-sectional differences in financial development across countries. In total, we collect the requisite data for a cross-section of almost 150 countries. The data on financial and economic development are collected from World Bank Open Data and the World Bank’s Global Financial Development Database. Data on genetic diversity are gathered by way of A&G. Data on the various control measures are gathered by way of A&G, Rajan and Zingales (2003), Acemoglu et al. (2001), and Chanda et al. (2014). A full description of the variables we use and their source can be found in Table 10. Financial Development (FD) The level of financial development in a country is multifaceted and quite complex, which makes it extremely hard to measure in practice (Rajan and Zingales, 2003). Financial development includes financial assets and instruments, the breadth of markets that trade these assets and instruments, and the financial institutions and intermediaries that connect the suppliers and demanders of capital. In an attempt to robustly capture a country’s level of financial development, we consider four different measures.5 These four measures are generally regarded as standard proxies for financial development and have been used in prior studies exploring 5 One of the primary objectives in this paper is to investigate the relation between genetic diversity and financial development coming directly through financial innovation. As such, the measures of financial development we consider mainly encompass equity markets characteristics. The reason being is that in a recent survey article, Cardella et al. (2014) discuss how financial innovation is likely to be more prevalent in areas of the financial sector related to equities markets vs. corporate bond markets due to increased use and implementation of technology (e.g., computerization). 14 financial development at the country level (e.g., King and Levine, 1993; Wurgler, 2000; Rajan and Zingales, 2003; Beck et al., 2003; Stulz and Willianson, 2003; Hsu et al., 2014). The first measure is stock market capitalization (Market Cap), where stock market capitalization is the total market value of all listed shares. The second measure is total stocks traded (Stocks Traded), where stocks traded is the total value of shares traded during a given year. The third measure is total listed companies (Stocks Listed), which is the total number of domestically listed companies on the country’s stock exchanges. These three measures are intended to proxy for the depth of financial markets. Our fourth measure, which is intended to proxy for investment risk and the protection of investors, is the risk of expropriation of investment (Expropriation Risk), where expropriation risk is a scaled measure of the average protection against the expropriation of private foreign investment by the government. This measure is borrowed from Acemoglu et al. (2001). The scale of this measure ranges from 0 (low protection/high risk) to 10 (high protection/low risk). For example, the United States (among the highest in our sample) has an expropriation risk measure of 10, while Sudan (among the lowest in our sample) has an expropriation risk of 4. Expropriation risk can be an important factor in financial development, as higher expropriation risk can deter investment and thus hamper financial sector growth. 6 Because our proxy for a country’s degree of genetic diversity is for year 2000 CE (the details of the construction of this variable are explained below), we collect data on the first three financial development proxies (Market Cap, Stocks Traded, and Stocks Listed) for each of the countries in our sample for each year from 1998 to 2002, i.e., a five-year window around the year in which a country’s degree of genetic diversity is measured. We then take the average over 6 We refer readers to p.56 of this report for a discussion of expropriation risk, and how it can deter equity investment:http://www.doingbusiness.org/~/media/FPDKM/Doing%20Business/Documents/AnnualReports/English/DB05-FullReport.pdf 15 these five years to generate a single value of financial development for each country for each of these three measures. The data for Expropriation Risk is a 10-year average from 1985-1995. We acknowledge that none of the proxy measures for financial development are all-encompassing. However, by considering four different measures and taking the average of each measure over a range of time, we hope to establish a more robust conclusion regarding the effect of genetic diversity on financial development. In our regression specification, the measures Market Cap, Stocks Traded, and Stocks Listed are not scaled by GDP. Rather, we employ a logarithm transformation of these variables to address the positive skewness that is present in these measures. These measures are intentionally not scaled by GDP for the following reason: Our main hypothesis is that genetic diversity has a hump-shaped effect on a country’s level of financial development; further, this effect comes through two channels: (i) directly through financial innovation, and (ii) indirectly through the demand for financial development. In order to investigate if genetic diversity does impact the level of financial development apart from its effect through the latter demand channel, it will be necessary to control for the demand for financial development (See specification 2 above). To proxy for a country’s level of demand for financial development, we will use the country’s per capita GDP (denoted as d in specification 2), which is used by Rajan and Zingales (2003) and also corresponds with the proxy of contemporary economic development used in A&G. As with the construction of our financial development measures, we average the yearly measure of per capita GDP across the five-year window of 1998 through 2002 and denote it Per Capita GDP; in all specifications, we also take the log transformation of Per Capita GDP to address the skewness in this measure. Thus, because we will be explicitly controlling for GDP, it is not necessary to scale the financial development measures by GDP. In addition, by not scaling our 16 financial development measures by GDP, we ensure that any observed relation between genetic diversity and financial development is not coming solely through its effect on GDP (i.e., impacting only the denominator). However, in all specifications where Per Capita GDP is not added as a control, we will include country population as a control to ensure that any relation between genetic diversity and financial development is not coming through differences in the size of the country. Genetic Diversity (gd) For the degree of a country’s genetic diversity, we adopt the measure developed and used by A&G. In what follows, we provide a sketch of what is meant by genetic diversity, how it is generally measured, and the method that A&G use in creating their measure of predicted genetic diversity at the country level. We refer interested readers to A&G for an unabridged and more thorough discussion of these topics. Population geneticists typically measure the degree of genetic diversity across individuals within a given population using an index called expected heterozygosity. This index can be interpreted as the probability that two randomly selected individuals from the relevant population are genetically different from one another; the higher this index, the more genetically diverse the population. To construct this index of expected heterozygosity, geneticists collect sample data on allelic frequencies (i.e., the frequency of a specific gene variant or allele) within the given sample population. Given the allelic frequencies, it is possible to construct a gene-specific measure of heterozygosity. Then, to construct an overall measure of expected heterozygosity, one simply averages this gene-specific heterozygosity measure over multiple genes for which 17 there is data.7 The most reliable data for genetic diversity consists of 53 ethnic groups from the Human Genome Diversity Cell Line Panel, compiled by the Human Genome Diversity ProjectCentre d’Etudes du Polymorphisme Humain (HGDP-CEPH) (Cann et al., 2002 and CavalliSforza, 2005).8 Anthropologists maintain that these 53 ethnic groups are not only native to their current locations but also have been essentially isolated from genetic flows from other ethnic groups. These 53 ethnic groups span a total of 21 countries, and based on the data from HGDPCEPH, it is possible to construct a measure of observed genetic diversity for these 53 ethnic groups based on expected heterozygosity. However, as noted by A&G, there are two main limitations with using this measure of observed genetic diversity. First, given that this observed genetic diversity data is available for only these 53 ethnic groups that span 21 countries, the sample using observed genetic diversity would be restricted to those 21 countries, which is a much smaller subset of countries than that for which we have data on economic and financial development. Second, and more important, there may be endogeneity between a country’s level of observed genetic diversity and its level of financial development. Specifically, genetic diversity within a country may be determined, in part, by migration patterns, which could have been influenced by a country’s level of economic and/or financial development. Furthermore, as argued by A&G, the direction of this possible 7 More formally, suppose there is a single gene, denoted as l, with a total of k observed variants or alleles in the 𝑙 given sample population. Then, the expected heterozygosity for that gene, denoted as 𝐻𝑒𝑥𝑝 , is given by: 𝑘 2 𝑙 𝐻𝑒𝑥𝑝 = 1 − ∑𝑖=1 𝑝𝑖 where 𝑝𝑖 denotes the probability of the ith allele. If there are m different genes, then the overall expected heterozygosity, denoted as 𝐻𝑒𝑥𝑝 , averaged over these m genes can be expressed as follows: 𝑚 𝐻𝑒𝑥𝑝 8 𝑘𝑙 1 = 1 − ∑ ∑ 𝑝𝑖2 𝑚 𝑙=1 𝑖=1 For a list of these 53 ethnic groups and the countries in which they reside, see A&G Appendix E. 18 endogeneity bias is ambiguous; on the one hand, it could have been the case that more developed countries were more attractive to migrants (increasing genetic diversity), while on the other hand, more developed countries could have had more developed infrastructure to limit the inflow of migrants (decreasing genetic diversity). As a result of the limitations associated with using actual observed genetic diversity, A&G propose a measure of predicted genetic diversity for each country in year 2000 CE that is based on the ethnic composition of that country as well as migratory distance from East Africa. As postulated by the serial-founder effect, as subgroups of the population migrated over the earth, they carried with them only a subset of the overall genetic diversity of the parent colony; hence, the further the migratory distance (out of East Africa), the less genetically diverse this sub-group. In particular, A&G build on the work from Ramachandran et al. (2005), who document that migratory distance from East Africa has a significant negative linear effect on observed genetic diversity within the 53 ethnic groups in the HGDP-CEPH data; they find that the variation in migratory distance explains 78 percent of the variation in genetic distance across the 1,378 ethnic group pairs and 86 percent of the cross-group variation in within-group diversity. Given the results of Ramachandran et al., A&G construct a measure of predicted genetic diversity for each country as follows: First, they identify the ethnic composition of each country based on the World Migration Matrix, 1500-2000 of Putterman and Weil (2010); this data compiles for each country the fraction of the 2000 CE population that is descended from the population of every other country in 1500 CE. Given this data on ancestral source countries, A&G construct a measure of predicted heterozygosity for each country that accounts for within-group genetic diversity and between-group genetic diversity. For within-group genetic diversity, A&G calculate the predicted level of genetic diversity 19 based on the migratory distance of the ancestral source country from Addis Ababa, Ethiopia. Specifically, they apply the coefficient of the effect of migratory distance on observed genetic diversity obtained by Ramachandran et al. (2005) (from the 53 ethnic groups and 21 countries in the HGDP-CEPH data). However, this alone does not account for the between-group genetic diversity of the ethnic composition of each country that results from post-1500 CE population flows. For the between-group component of genetic diversity, A&G incorporate a measure of genetic diversity between two populations that is referred to by population geneticists as genetic distance. Again, A&G appeal to the results from Ramachandran et al., who also show there is a strong positive correlation between pairwise genetic distances and pairwise migratory distances from East Africa. Using the coefficient estimate from Ramachandran et al., A&G calculate the predicted level of between-group genetic diversity across all pairs of ethnic groups within a country. Given the estimates of within and between-group genetic diversity, which are both predicted from migratory distance, A&G construct an overall measure of genetic diversity that is essentially a weighted average given the ethnic composition of each country in 2000 CE. A&G refer to this measure as the ancestry adjusted measure of predicted genetic diversity. This predicted measure of genetic diversity minimizes endogeneity concerns based on the assumption that prehistoric migratory paths out of Africa had no direct effect on Common Era development. It is this predicted measure of genetic diversity for each country in year 2000 CE, which we denote as Diversity, which we adopt as our measure of genetic diversity in our analysis. For the remainder of the paper, we will drop the predicted qualifier for brevity and simply refer to this as the measure of genetic diversity; however, it is implied that this is a predicted measure rather than the actual measure of observed genetic diversity. Other Possible Factors Affecting Financial Development 20 In the existing literature, several factors have been shown to influence a country’s level of financial development. The factors include: the type of legal origins (La Porta et al., 1998; Beck et al., 2003); the trade and capital openness of a country (Rajan & Zingales, 2003); the country’s endowment (Acemoglu et al., 2001; Beck et al., 2003); and its cultural factors (Stulz & Williamson, 2003). Below, we describe the variables that we use to attempt to control for the effect of these other possible factors on financial development. With regard to legal origin, the idea, as argued by La Porta et al. (1999), is that the type of legal origin can influence financial development through two possible channels: The first is the priority placed on protecting property rights, and the second is the protection of private contracting rights. The two main types of legal origins are the British Common Law system, which evolved to protect private property rights, and the French Civil Law system, which was designed to reinforce the power of the State. As a result, British Common Law systems are regarded as being more conducive for financial development (Beck et al. 2003). To control for the effect of legal origins, we use the data from La Porta et al. (1998) and A&G on the type of legal origin for each country. In particular, in our regressions we construct the following dummy variables for legal origin of a country: Legal Origin UK (British Common law), Legal Origin FR (French Civil law), and Legal Origin Other (all other forms of legal origin), which is the excluded category in the regression analysis.9 With regard to openness, Rajan and Zingales (2003) argue that when the country’s borders are open to trade and capital flows, financial development is improved. Following Rajan and Zingales (2003), we use the sum of exports and imports of goods divided by GDP as a proxy for 9 These other forms of legal origin include: German Law, Socialist or Communist Law, and Scandinavian Law. The regression results reported later are robust if we include dummy variables for each legal origin. 21 a country’s level of trade openness. We collect data for each year for the periods of 1998 through 2002 and take the average over these five years. The resulting country-level proxy is denoted as openness in our regression analyses. The endowment theory emphasizes the roles of a country’s geography and its disease environment in shaping migration and subsequent institutional development and growth (Acemoglu et al., 2001). Beck et al. (2003) provide evidence that a country’s endowment, as proxied for by settler mortality rate in the early nineteenth century, does impact a country’s level of financial development.10 To control for possible different environmental endowment levels across countries, we use the percentage of the population (in 1994) that was at risk of contracting falciparum malaria, denoted as Malaria; this measure was obtained from A&G and originally constructed by Gallup and Sachs (2001). Because of data constraints, we opt to use the Malaria proxy for a county’s endowment in lieu of the settler mortality. Specifically, in our specification with a full set of controls, our sample sizes for Market Cap, Stocks Traded, and Stocks Listed would be reduced to 45, 45, and 48 country observations, respectively. We also note that the Malaria measure to proxy for endowment is used in Acemoglu et al. (2001) and A&G, and is highly correlated with settler mortality r = .6744 (p < .001). Lastly, it has been shown that cultural differences across countries can play a role in shaping differences in financial development (Stulz & Williamson, 2003). Specifically, Stulz & Williamson documented a negative association between some proxies for financial development 10 Their study provides evidence for both the law and endowment theories. However, their results show that initial endowments explain more of the cross-country variation in financial intermediary and stock market development across countries. 22 they consider (e.g., measures of creditor rights) and counties that are predominately Catholic.11 In order to control for the possible effect of religion, we include as a control the percentages of a country’s population that is Catholic, denoted as P_Catholic.12 3.3 Summary Statistics and Correlations Table 1 reports summary statistics of all variables used in our analysis. We conduct a crosssectional regression analysis at the country level for each of the four proxies of financial development we consider: Market Cap, Stocks Traded, Stocks Listed, and Expropriation Risk. Depending on the measure of financial development that is used, the number of observations in each corresponding regression specification is different based on availability of the data. Thus, the summary statistics in Table 1 are broken down based on the corresponding measure of financial development: Panel A for Market Cap, Panel B for Stocks Traded, Panel C for Stocks Listed, and Panel D for Expropriation Risk. With regard to the financial development measures, Panel A shows that the mean of Market Cap is about $297 billion. Panel B reveals that the mean of Stocks Traded is about 349 billion. Panel C reveals that mean Stocks Listed is 442, which means on average each country has 442 companies domestically listed. Lastly, Panel D reveals that the mean of Expropriation Risk is 7.0364 (on a 10-point scale). It is important to point out here that for each of the first three measures of financial development, the mean is substantially higher than the median. This 11 However, Beck et al. (2003) show that religion of a country has very little effect on the measures of financial development they consider after controlling for legal origin of the country. 12 We note that the results from our main specifications are generally robust if we include the fraction of the population belonging to Protestant and Muslim. Furthermore, the results are generally robust if we include the ethnic fractionalization (Beck et al., 2003) of each country as a control. That said, consistent with the finding in Beck et al., these variables seem to have little residual effect on financial development and are rarely significant in the regression results. Given our small sample size and the relatively extensive set of control variables we consider, we report our results without the inclusion of these additional controls. In addition, if we perform a stepwise iterative approach for selecting control variables, neither Protestant, nor Muslim, nor ethnic fractionalization survives as selected control variables. 23 indicates, as we would expect, the presence of substantial positive skewness and outliers at the upper end of the distribution of financial development. In order to mitigate the possibility that our results may be driven by such outliers, we take logarithmic transformations of each of the first three financial development measures in our analyses that follow. In terms of genetic diversity in the sample of countries, we see from Table 1 that the variable Diversity of a country ranges from about 0.63 to 0.77 in our sample, with a standard deviation of 0.028. In our sample, the least genetically diverse country is Bolivia, while the most genetically diverse country is Uganda. For comparison, the USA ranks 42nd with Diversity = 0.72. Table 2 reports the pairwise correlations among the four measures of financial development we consider. From Table 2, we can see that the correlations range from 0.43 to 0.96. That fact that they are all strongly positively correlated with each other (p < .001 for each pairwise correlation) suggests that each of the four measures is a reasonable proxy for level of financial development. At the same time, the fact that the correlations are not very near to one suggests that there is some variation in the components of development in the financial sector each these measures is capturing. Hence, a consideration of all four different measures in our upcoming analysis will provide a robust picture of how genetic diversity impacts financial development. 4 Results This section reports the main results of our empirical investigation of the relation between a country’s degree of genetic diversity and its level of financial development. The dependent variable in our analysis is one of the four measures of financial development (described in Section 3.2). For each specification, we report the results for all four measures of financial development. Overall, the empirical findings indicate a significant hump-shaped relation 24 between a country’s degree of genetic diversity and its level of financial development. This relation persists even after controlling for other country-level characteristics that have previously been shown to impact financial development, as well as controlling for per capita GDP (i.e., the demand for financial development). 4.1 Overall Relation of Genetic Diversity and Financial Development We first look at the overall relation of genetic diversity and financial development. Table 3a reports the results from the unconditional cross-sectional regressions of each of the four financial development measures on Diversity and its square, which we denote Diversity Sqr.13 From Table 3a, we see that the coefficient on Diversity is positive and significant at the 1% level for all four measures of financial development. In addition, the coefficient on Diversity Sqr is negative and significant at the 1% level for all four measures. In Table 3b, we additionally control for county population, and the linear coefficients on Diversity remain positive and significant, while the quadratic coefficients on Diversity Sqr remain negative and significant. This provides initial evidence consistent with our main hypothesis of the overall hump-shaped association between genetic diversity and financial development. Based on our coefficient estimates, one can calculate the estimated degree of genetic diversity where financial development is maximized. The last row in each panel of Table 3 reveals that the predicted values of Diversity where financial development is maximized range from 0.669 to 0.707 (depending on which of the four measures of financial development is used). Examples of some countries close to this maximizing level of Diversity include: Japan, China, 13 In addition, we include continent dummy variables in all regression specifications to control for continent fixed effects. Hence, we will not continue to reiterate that continent dummies are included in each specification, as they are included in every specification. In addition, because we are using generated genetic diversity measures from an implicit first-stage regression, in our regressions, we bootstrap all standard errors with 500 replications. 25 Mexico, Columbia, and Belize. Given that Diversity ranges from 0.63 to 0.77 in our sample, this confirms the hump-shaped relation between genetic diversity and financial development, namely, intermediate levels of genetic diversity are associated with the highest levels of financial development. To explore the robustness of the hump-shaped effect of genetic diversity on financial development, we add in a full set of country-level control variables that have previously been shown to impact a country’s level of financial development (these are described in detail in Section 3.2). Table 4 reports the relevant results. From Table 4, we see that for all four measures of financial development, the coefficient on Diversity remains positive and significant. Moreover, the coefficient on Diversity Sqr also remains negative and significant. In terms of the magnitude of the relation between genetic diversity and financial development, it is useful to look at the elasticity of financial development with regard to Diversity. For brevity, we report only on the Market Cap measure and calculate the elasticity at the level of Diversity one standard deviation below the maximizing level of 0.710 (reported in the last row of Table 4), as well as one standard deviation above. Given the coefficients from Column 1 of Table 4, a 1 percentage point increase in Diversity at one standard deviation below the maximizing level implies an approximately 18 percent increase in Market Cap. On the other hand, a 1 percentage point decrease in Diversity at one standard deviation above the maximizing level implies an approximately 19.5 percent increase in Market Cap. As a result, the overall hump-shaped relation between genetic diversity and financial development remains significant even after controlling for other factors that can possibly affect financial development. In general, looking across the control variables, the signs of the coefficients are generally in the direction to be expected, given the prior literature. Namely, Legal Origin FR has a smaller 26 coefficient than Legal Origin UK, indicating a negative effect of financial development compared to Legal Origin UK. Malaria is negative and significant. While Openness is not always significant, it is positive. Importantly, the magnitude of the coefficients on Diversity and Diversity Sqr are generally consistent even after adding in the full set of control variables, and remain statistically and economically significant. The last row of Table 4 reveals the predicted level of Diversity, estimated from the regression coefficients, where each proxy of financial development is maximized. From Table 4, we see that the values range from 0.700 to 0.710; similar to the result from Table 3, this is consistent with the notion that intermediate degrees of genetic diversity are associated with higher levels of financial development. 4.2 Direct Relation of Genetic Diversity and Financial Development We hypothesized that there are two possible channels through which genetic diversity can impact financial development. The first is directly through its effect on financial innovation and the subsequent supply of financial development, while the second is indirectly through its effect on economic development and the subsequent demand for financial development. To attempt to separate these two effects, we a proxy for economic development to control for a country’s demand for financial development. Table 5 replicates Table 3b, displaying the results of the effect of genetic diversity on financial development with the inclusion of Per Capita GDP – our proxy for a country’s level of economic productivity. Generally consistent with our hump-shaped prediction, we observe that the coefficient associated with Diversity is still positive and significant (for 3 of 4 measures), and the coefficient associated with Diversity Sqr is negative and significant (for 3 of 4 measures). As expected, the coefficient on Per Capital GDP is positive and highly significant for all four measures. Again, the last row of Table 5 indicates that the estimated values of genetic diversity for which the financial development measures reach their 27 maximum are intermediate levels and range between 0.676 and 0.696. In Table 6, we add in the full set of controls, and the results are robust. Namely, the coefficients on Diversity continue to be positive and significant, while the coefficients on Diversity Sqr are negative and significant. In terms of the magnitude of this hump-shaped relation, we can do a similar elasticity-type calculation as reported above. In particular, based on the coefficient estimates in Column 1 of Table 6, a 1 percentage point increase in Diversity (at one standard deviation below the maximizing level of 0.669) implies an approximate increase of 17 percent in Market Cap. Conversely, a 1 percentage point decrease in Diversity (at one standard deviation above the maximizing level of 0.669) implies an approximate increase of 18.5 percent in Market Cap. In terms of the controls, Per Capita GDP remains positive and significant. After controlling for Per Capital GDP, we see that the coefficient on Legal Origin FR has a smaller coefficient than Legal Origin UK, indicating a negative effect of financial development compared to Legal Origin UK. The coefficient on Malaria becomes insignificant, while the coefficient on Openness becomes negative and significant.14 14 There is a strong negative correlation between Malaria and Per Capita GDP, which is the reason the coefficient on Malaria becomes insignificant when Per Capita GDP was included in Table 6, as compared to when Malaria was strongly positively significant in Table 4. With regards to Openness, the negative and significant coefficient is surprising. Stulz and Williamson (2003), however, also find a negative and significant relationship between shareholder rights index and openness, and indicate that this negative coefficient is due to a negative relation between openness and the dummy variable for cumulative or proportional voting. This is in contrast to the results reported in Rajan and Zingales (2003), who find a positive and significant coefficient on Openness. We take the analysis of the data further to offer a better understanding of these discrepancies. It should be noted that both Stulz and Williamson (2003) and Rajan and Zingales (2003) consider scaled measures of financial development (e.g., Market Cap / GDP), while we consider unscaled measures of financial development (e.g., Market Cap). After analyzing the correlations in the data, we find a strong negative correlation between Openness and GDP (the denominator of their scaled measures). We note that we are by no means implying that this negative cross-sectional correlation implies a causal relationship given the likely endogeneity between Openness and GDP. Rather, we suggest that this negative correlation is likely driving the difference in the effect of Openness between our results and those of Rajan and Zingales. Specifically, if we take, for example, our unscaled Market Cap measure, we find a negative correlation between Openness and Market Cap; hence, it is not surprising that the coefficient on Openness 28 Taken together, the results from Tables 5 and 6 indicate that, even after controlling for the level of demand for financial development as proxied by Per Capita GDP, we observe a persistent hump-shaped relation between a country’s financial development and its degree of genetic diversity. This result is consistent with our hypothesized prediction that genetic diversity can impact financial development through two channels: (i) directly through its effect on innovation in the financial sector, which is not captured through a country’s level of GDP and the demand for financial development, and (ii) indirectly through its effect on productivity and the subsequent demand for financial development. 4.3 Addition of Schooling and Social Infrastructure In this section, we explore the role of a country’s degree of human capital and social capital in influencing the level of financial development. The motivation for this is twofold: First, we want to ensure that our results regarding the observed hump-shaped relation between genetic diversity and financial development are not being driven by cross-section differences in these two characteristics of the country. Second, by investigating how human capital and social capital can impact financial development, we can shed light on possible feasible mechanisms through which a country can increase its financial development. To proxy for human capital, we use average years of schooling for the population in the country, which we get by way of A&G and denote as is negative and significant for the Market Cap measure (column 1 of Table 6). However, the negative relation between Openness and GDP dominates the negative relation between Openness and Market Cap. This pattern generates an overall positive relation of Openness to the relation of Market Cap/GDP, which is what Rajan and Zingales document. Thus, it is the difference in the way in which we measure financial development (scaled vs unscaled by GDP), in combination with the observed negative relation between Openness and GDP, that is able to reconcile the difference in the effect of Openness between our results and those of Rajan and Zingales. Furthermore, consistent with Rajan and Zingales, we are able to generate a positive coefficient on Openness if we use Market Cap / GDP and Stocks Listed/Population as our dependent variables in specifications in Table 6. This discussion also reinforces the fact that if we are interested in disentangling the two channels (the demand channel and the innovation channel) through which financial development is affected by the genetic diversity of a country, we should not scale our dependent variables. 29 School. Our proxy for social capital is the social infrastructure index originally developed by Hall and Jones (1999), which we get by way of A&G and denote as Social Inf. This index is from 0 to 1 with a higher value indicating better social infrastructure. Hall and Jones describe social infrastructure as “the institutions and government policies that determine the economic environment within which individuals accumulate skills, and firms accumulate capital and produce output” (p. 84). Hence this Social Inf index, which is a weighted average over many different components of social infrastructure, is intended to proxy for a country’s overall level of social infrastructure. Table 7 Panel A presents the results of our main specification of the regression of financial development on genetic diversity, per capita GDP, controls, and the inclusion of the School variable. For all four financial development measures, the coefficient on Diversity is positive and significant, while the coefficient on Diversity Sqr is negative and significant, indicating the persistent hump-shaped relation of genetic diversity and financial development. Importantly, the School proxy is positive and enters in significantly for 3 of 4 financial development measures. This suggests a positive association between the amount of schooling and the level of financial development. In Panel B of Table 7, we add Social Inf as a control variable. From Panel B, we see that for all four financial development measures, the coefficient on Diversity is, again, positive and significant while the coefficient on Diversity Sqr is negative and significant; this further indicates the persistent hump-shaped effect of genetic diversity on financial development. Furthermore, Social Inf is positive and significant for 3 of 4 financial development measures, which suggests that higher levels of social infrastructure within a country is associated with higher levels of financial development. In terms of the magnitude of the relation between schooling and financial development, the 30 coefficient on School for the Market Cap proxy (Table 7 Panel A) implies that an increase in School by 1 year of the population within a country is associated with an approximately 19 percent increase in Market Cap. To put this into context, the coefficient estimates in the same specification imply that a 1 percentage point increase in Diversity (at one standard deviation below the maximizing level) is associated with an approximate increase of 17.5 percent in Market Cap; conversely, a 1 percentage point decrease in Diversity (at one standard deviation above the maximizing level) implies an approximate increase of 19 percent in Market Cap. In terms of the magnitude of relation of social infrastructure to financial development, the coefficient on Social Inf for the Market Cap proxy (Table 7 Panel B) implies that an increase of 10 percent in the Social Inf index is associated with an approximately 16 percent increase in Market Cap. The coefficient estimates in the same specification imply that a 1 percentage point increase in Diversity (at one standard deviation below the maximizing level) is associated with an approximate increase of 20 percent in Market Cap; conversely, a 1 percentage point decrease in Diversity (at one standard deviation above the maximizing level) implies an approximate increase of 21.5 percent in Market Cap. Taken together, our results suggest that the magnitude of the increase in financial development association with an increase in schooling by 1 year or an increase in the social infrastructure index by 10% would comparable in magnitude to the increase in financial development associated with a 1% change in genetic diversity. 5 Additional Robustness Analysis Next, we address the possibility that the predicted measure of genetic diversity that we use in the analysis is endogenous to financial development. Recall that the genetic diversity measure for each country comprises two sources: (i) the within-ethnic group genetic diversity, and (ii) the between-group genetic diversity between each pairwise ethnic group comparison. A predicted 31 measure of each of these sources was then calculated based on prehistoric migratory distance from East Africa; thus, the predicted measure of each component or genetic diversity is likely exogenous to current levels of financial development. That said, the overall measure of predicted genetic diversity (Diversity) is determined, in part, by the number of different ethnic groups within a country and the concentration of each ethnic group. Thus, there is a possibility for this measure of predicted genetic diversity to be endogenous to financial development to the extent that financial development may have impacted the post-1500 CE population flows and the current ethnic composition of each country. Said differently, it is possible for there to have been post-1500 CE migration away from less financially developed countries and toward more financially developed counties, which would then increase the between-group source of genetic diversity in these countries.15 We address this possible endogeneity issue in two ways: (i) with an alternative measure of predicted genetic diversity, and (ii) with a sub-sample analysis. 5.1 Alternative Measure of Predicted Genetic Diversity Instead of using the Diversity measure of genetic diversity, which was ancestry adjusted to account for post-1500 migration, we use an alternative measure created by A&G that is based strictly on migratory distance. The construction of this measure, denoted as Alt Diversity, is solely based on the migratory distance of each country from East Africa and does not take into account the ethnic composition of the country.16 Thus, there is no scope for post-1500 CE migration flows to impact the genetic diversity measure. As a result, we contend that this measure, predicted solely on prehistoric migratory distance, is exogenous to contemporary levels 15 A&G discuss this same possibility of endogeneity of this measure of genetic diversity to the level of economic development. 16 A&G use this Alt Diversity distance-only based measure to investigate the effect of genetic diversity on economic development in 1500 CE when, presumably, there was little migratory flows and insufficient data on ethnic composition within a country. 32 of financial development. Furthermore, the Alt Diversity measure is strongly correlated with the Diversity measure (correlation coefficient of 0.75 and p-value < .0001). Table 8 presents the results with Alt Diversity serving as the independent variable for genetic diversity. From Table 8, we can see that this measure of genetic diversity has a significant humpshaped relation to the level of financial development (in 3 of the 4 measures), even after including the full set of control variables. Hence, our main results regarding the relation of genetic diversity and financial development are generally robust to this more crude measure of a country’s degree of genetic diversity, which is more likely to be exogenous to contemporary levels of financial development. We note here that the distance-only based measure of genetic diversity (Alt Diversity) is indeed a cruder and less accurate predicted measure of actual genetic diversity than the ancestry-adjusted measure (Diversity) since it does not account for betweengroup diversity arising from migration flows.17 For this reason, combined with the fact that our results are generally robust if using the less informative Alt Diversity measure (as indicated in Table 8), the main analysis in our paper is done using the ancestry-adjusted Diversity measure. 5.2 Subsample Analysis The second way we address the possibility that the Diversity measure we use in our main analysis in Section 4 is endogenous to a country’s current level of financial development is through subsample analysis. In particular, it is not clear or obvious whether this possible endogeneity would lead to a positive or negative bias regarding the effect of genetic diversity on financial development. In particular, extending the argument put forth by A&G, more 17 In fact, if we regress measures of financial development on Alt Diversity, Alt Diversity Sqr, Diversity, and Diversity Sqr, then only Diversity, and Diversity Sqr are significant. That is, the ancestry-adjusted measures do dominate the unadjusted distance-only measures, which is consistent with the findings reported in A&G with regard to the effect of genetic diversity on economic development. 33 developed/advanced countries may have been more attractive to migrate to, thus increasing genetic diversity; at the same time, these more developed/advanced countries could have been more effective at minimizing immigration (if they chose to do so), thus decreasing genetic diversity. That being said, we test the robustness of our results using various sub-samples where we exclude from the sample various countries that may be more desirable to migrate away from because of lower levels of financial development, as well as those countries that may be more desirable to migrate to because of higher levels of financial development. Table 9 presents the results of the effect of genetic diversity on each of the four financial development measures for each different sub-sample (Panels A-E) with the inclusion of Per Capita GDP and other controls. Consistent with Beck et al. (2003), we drop P_Catholic from the sub-sample analysis as it is never significant at the 10% level for any of the previously reported specifications for any of the four financial development measures. In Panel A of Table 9, we exclude the 30 OECD countries from our sample (i.e., those countries that may be more attractive to migrate to as suggested by A&G). From Panel A, we see that for two of the four measures (Stocks Traded and Stocks Listed) the coefficient on Diversity is positive and significant, while the coefficient on Diversity Sqr is negative and significant, revealing a hump-shaped effect. For the other two measures (Market Cap and Expropriation Risk), Diversity and Diversity Sqr are not significant, although the direction is hump-shaped, and the magnitudes of the coefficients are very similar to the full sample reported in Table 6. Panel B reports the results where we omit 48 Sub-Saharan African countries (i.e., those counties that may have been less attractive to migrate to and generally have more genetic diversity as suggested by A&G). Panel B reveals a positive and significant coefficient on Diversity, and a negative and significant coefficient on Diversity Sqr for all four measures of financial development. 34 In Panels C through E of Table 9, we attempt to control for the possible increased international flow of capital over the last several decades (Laeven, 2014). Specifically, Laeven documents “the capitalization of stock markets (relative to GDP) saw an increase of about 50 percent globally but a more than twofold increase in upper middle income countries over this period [1994-2010]” (p. 6). He goes on to document that the capitalization of stock markets and the number of listed companies has actually decreased over that period for low income countries. To ensure that our results are not being driven by this somewhat recent increase in international capital flows recently discussed by Laeven (2014), we consider three additional sub-samples where we omit the 10% of highest GDP per capita countries (Panel C), the 10% of lowest GDP per capita countries (Panel D), and both the 10% of highest and the 10% of lowest GDP per capita countries (Panel E). From Panels C-E, we see that the significant hump-shaped effect of genetic diversity generally persists across the various subsamples and measures of financial development. Namely, in 11 of the 12 total specifications, the coefficient on Diversity is positive and significant, while the coefficient on Diversity Sqr is negative and significant. These results from Table 9 indicate that the hump-shaped relation of genetic diversity on financial development remains robustly intact when we look at sub-samples of countries where we omit countries that may be more or less prone to migrations, as well as omit the relatively high and low income counties. Taken together, this suggests that the strong hump-shaped effect we document between a country’s degree of genetic diversity and the measures of financial development in our main analysis (Table 6) is not strictly an artifact of migration flows for more financially developed countries or capital flows toward higher income countries. 6 Conclusion It is well established in the literature that development in a country’s financial sector is an 35 important component of its growth process. At the same time, ample empirical evidence documents considerable heterogeneity in financial development across countries. This has spurred much research aimed at identifying possible factors that can influence financial development and thus accounts for differences across countries. Subsequently, many structural, institutional, cultural, and political factors have been shown to influence financial development. In this paper, we take a complementary approach by investigating if and to what extent a country’s level of genetic diversity impacts its level of financial development. Building on the recent work from Ashraf and Galor (2013), we hypothesize that a country’s level of financial development is determined based on two components: (i) the country’s level of financial innovation (the supply of financial development), and (ii) the country’s level of economic development (demand for financial development). We assert that a country’s degree of genetic diversity can impact the total level of financial development through each of these two channels. Paralleling the argument put forth by Ashraf and Galor, we hypothesize that genetic diversity will have a hump-shaped relation with financial development; namely, when genetic diversity is low, we will observe a positive relation between financial development and genetic diversity, while at high enough levels of genetic diversity we will observe a negative relation between genetic diversity and financial development. We test this hypothesis empirically using a cross section of almost 150 countries. In doing so, we gather data on a country’s level of financial development, its degree of genetic diversity, its demand for financial development, as well as other controls that have received attention in the literature. The measure of genetic diversity we use is adopted from Ashraf and Galor, and is determined based on the ethnic composition of a country combined with prehistoric migratory distances of ethnic groups out of East Africa. As predicted, our results indicate a significant hump-shaped relation between a country’s 36 degree of genetic diversity and its level of financial development. These results are robust across four different proxy measures of financial development that we consider. Furthermore, the results are robust after controlling for a country’s demand for financial development, which is consistent with our hypothesis that genetic diversity impacts financial development through its effect on financial innovation. Our results remain robust even after controlling for other factors that have been shown in the extant literature to impact financial development; these include the country’s type of legal origin, its degree of openness, its initial endowment, and its religion. Furthermore, the hump-shaped effect of genetic diversity is persistent even when we consider subsamples where we omit countries that may be more or less desirable to migrate to, as well as omit those countries with relatively low and high income levels. Given the close link between the functioning of a country’s financial sector and its economic development and growth, it is important to understand factors that can shape financial development. Similar to the view of Rajan and Zingales (2003), we assert that the existing theories regarding factors that can influence financial development are not wrong; rather, they are incomplete. Our results suggest that some of the variation in financial development across country’s may be the result of a more deep rooted factor – the degree of genetic diversity within its population. 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(Eds.), Handbook of the Economics of Finance, vol. 1A. North-Holland, Amsterdam, pp. 307-336. Wallace, Björn, David Cesarini, Paul Lichtenstein, and Magnus Johannesson, 2007, Heritability of ultimatum game responder behavior, Proceedings of the National Academy of Sciences 104, 15631-15634. Wurgler, Jeffrey, 2000, Financial markets and the allocation of capital, Journal of Financial Economics 58, 187-214. Zingales, Luigi, 2015, Does finance benefit society, CEPR Discussion Paper No. DP10350 Zyphur, Michael J., Jayanth Narayanan, Richard D. Arvey, and Gordon J. Alexander, 2009, The genetics of economic risk preferences, Journal of Behavioral Decision Making 22, 367-377. 41 Table 1 – Summary Statistics This table reports summary statistics. Panel A reports the statistics for the subsample used when Market Cap is the measure of financial development. Market Cap is the stock market capitalization in billion dollars averaged across 1998 – 2002. Panel B reports the statistics for the subsample used when Stocks Traded is the measure of financial development. Stocks Traded is the total value of shares traded in billion dollars averaged across 1998 – 2002. Panel C reports the statistics for the subsample used when Stocks Listed is the measure of financial development. Stocks Listed is the total number of domestically listed companies on the country’s stock exchanges averaged across 1998 – 2002. Panel D reports the statistics for the subsample used when Expropriation Risk is the measure of financial development. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013). Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Openness is the sum of import and export divided by GDP averaged across 1998 – 2002. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. P_Catholic is the percentage of a country’s population belonging to Roman Catholic. Malaria is the percentage of the population at risk of contracting malaria. Population is the population of the country in millions. School is the average years of schooling amongst the population. Social Inf is an index (ranging from 0 to 1) capturing the overall quality of institutions and government policies with a country. Panel A – Analysis with Market Cap Variable Mean Market Cap 297 Diversity 0.7225 Per Capita GDP 12039.0 Openness 0.85 Legal Origin UK 0.3535 Legal Origin FR 0.3434 P_Catholic 32.88 Population 53.34 Malaria 0.1517 School 5.82 Social Inf 0.5584 Panel B – Analysis with Stocks Traded Variable Mean Stocks Traded 349 Diversity 0.7226 Per Capita GDP 12152.8 Openness 0.85 Legal Origin UK 0.3469 Legal Origin FR 0.3469 P_Catholic 33.22 Population 53.88 Malaria 0.1484 School 5.8280 Social Inf 0.5584 Median 7 0.7313 4544.9 0.77 0 0 13.10 10.24 0 5.85 0.5037 Std 1520 0.0278 15091.6 0.52 0.4805 0.4773 37.29 166.46 0.2958 2.63 0.2475 Min 0 0.6279 270.9 0.20 0 0 0 0.39 0 0.69 0.1563 Max 14680 0.7653 70438.6 3.45 1 1 97.30 1261.90 1 10.86 1 N 99 99 98 98 99 99 99 99 96 84 79 Median 1 0.7315 4642.1 0.76 0 0 13.75 10.25 0 5.8450 0.5037 Std 2336 0.0280 15127.7 0.52 0.4784 0.4784 37.34 167.23 0.2957 2.6347 0.2475 Min 0 0.6279 270.9 0.20 0 0 0 0.39 0 0.6922 0.1563 Max 23050 0.7653 70438.6 3.45 1 1 97.30 1261.90 1 10.8622 1.0000 N 98 98 97 97 98 98 98 98 95 84 79 42 Panel C – Analysis with Stocks Listed Variable Mean Stocks Listed 442 Diversity 0.7221 Per Capita GDP 12227.9 Openness 0.8402 Legal Origin UK 0.3364 Legal Origin FR 0.3645 P_Catholic 33.33 Population 50.15 Malaria 0.1411 School 5.7441 Social Inf 0.5549 Median 116 0.7313 4646.6 0.7700 0 0 13.10 10.21 0 5.7306 0.5033 Panel D – Analysis with Expropriation Risk Variable Mean Median Expropriation Risk 7.0364 7.0455 Diversity 0.7246 0.7326 Per Capita GDP 10707.25 2711.90 Openness 0.7806 0.6494 Legal Origin UK 0.3217 0.0000 Legal Origin FR 0.5217 1.0000 P_Catholic 33.2235 13.1000 Population 49.17 11.32 Malaria 0.3370 0.0281 School 4.6183 4.2550 Social Inf 0.4681 0.3896 43 Std 1072 0.0281 15503.7 0.5000 0.4747 0.4836 37.71 160.47 0.2866 2.6188 0.2438 Min 2 0.6279 270.9 0.2003 0 0 0 0.39 0 0.6922 0.1563 Max 7133 0.7653 70438.6 3.4491 1.0000 1.0000 97.30 1261.90 1 10.8622 1 N 107 107 106 106 107 107 107 107 104 88 82 Std 1.8029 0.0290 15401.45 0.5123 0.4692 0.5017 37.4440 154.75 0.4285 2.7357 0.2514 Min 1.6364 0.6279 135.23 0.0104 0.0000 0.0000 0.0000 0.39 0.0000 0.4089 0.1127 Max 10.0000 0.7743 70438.59 3.4491 1.0000 1.0000 97.3000 1261.90 1.0000 10.8622 1.0000 N 115 115 112 112 115 115 115 115 113 98 105 Table 2 – Pearson Correlation Coefficients of Transformed Financial Development Measures This table reports the correlation matrix of four measures of financial development. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the average risk of expropriation of investment over 1985 - 1995. Log(Market Cap) Log(Stocks Traded) Log(Stocks Traded) 0.9629 (p <.0001) Log(Stocks Listed) 0.7022 (p <.0001) 0.7671 (p <.0001) Expropriation Risk 0.6737 (p <.0001) 0.6707 (p <.0001) 44 Log(Stocks Listed) 0.4322 (p <.0001) Table 3 – Financial Development and Genetic Diversity This table reports the unconditional relationship between financial development and genetic diversity. Panel A reports the regression of the four measures of financial development on genetic diversity and its square. Panel B reports the regression of the four measures of financial development on genetic diversity, its square and logarithm of population. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Log(Population) is the country’s population. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Panel A Diversity Diversity Sqr Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 1412.8*** (480.7) -1010.4*** (341.0) 2139.9*** (613.3) -1527.1*** (433.8) 771.7*** (269.7) -552.0*** (190.2) Expropriation Risk 596.7*** (178.4) -425.2*** (126.8) Yes Yes Yes Yes 99 0.101 98 0.216 107 0.137 115 0.492 0.699 0.701 0.699 0.702 Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 1178.1*** (432.6) -836.0*** (309.0) 1.043*** (0.163) 1778.8*** (548.0) -1260.2*** (389.2) 1.332*** (0.189) 580.0** (232.7) -410.2** (165.1) 0.606*** (0.0689) Expropriation Risk 597.4*** (178.6) -425.4*** (126.9) 0.0308 (0.0880) Yes Yes Yes Yes 99 0.392 98 0.484 107 0.467 115 0.488 0.705 0.706 0.707 0.702 Panel B Diversity Diversity Sqr Log(Population) Continent Dummies N Adj R2 Maximizing Level of Diversity 45 Table 4 – Financial Development and Genetic Diversity with Controls This table reports the regression of financial development on genetic diversity, its square, and controls. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Log(Population) is the logarithm of population. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. Malaria is the percentage of the population at risk of contracting malaria. Openness is the sum of import and export divided by GDP averaged over 1998 – 2002. P_Catholic is the percentage of a country’s population belonging to Roman Catholic. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Diversity Diversity Sqr Log(Pop) Legal Origin FR Legal Origin UK Malaria Openness P_Catholic Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Stocks Traded) 694.5* (386.2) -489.3* (277.2) 1.379*** (0.190) 2.378*** (0.697) 2.398*** (0.828) -3.200*** (1.148) 1.313* (0.679) -0.00301 (0.00888) 1209.5** (470.0) -856.5** (337.4) 1.636*** (0.269) 2.684*** (0.788) 3.057*** (1.044) -4.555*** (1.445) 0.904 (0.972) -0.00751 (0.0114) 442.3** (210.5) -315.7** (150.0) 0.667*** (0.0855) 0.642 (0.395) 0.904** (0.436) -1.649** (0.662) 0.291 (0.259) -0.00774* (0.00434) 468.0*** (162.3) -333.6*** (116.8) 0.0428 (0.121) -0.471 (0.366) 0.274 (0.394) -1.359*** (0.386) 0.152 (0.373) 0.00220 (0.00498) Yes Yes Yes Yes 95 0.551 94 0.596 103 0.527 110 0.559 0.710 0.706 0.700 0.701 46 Log(Stocks Listed) Expropriation Risk Log(Market Cap) Table 5 – Financial Development and Genetic Diversity with Demand Proxy This table reports the regression of financial development on genetic diversity, its square, and the demand for financing. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Diversity Diversity Sqr Log(Per Capita GDP) Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks traded) Log(Stocks Listed) 496.0 (394.1) -366.8 (279.7) 1084.9** (529.0) -784.5** (374.4) 643.5** (260.7) -462.5** (184.1) Expropriation Risk 353.9** (161.1) -257.2** (115.3) 1.623*** 1.804*** 0.272** 0.632*** (0.192) (0.256) (0.137) (0.0902) Yes Yes Yes Yes 98 0.474 97 0.485 106 0.166 112 0.662 0.676 0.691 0.696 0.687 47 Table 6 – Financial Development and Genetic Diversity with Demand Proxy and Controls This table reports the regression of financial development on genetic diversity, its square, and controls. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Openness is the sum of import and export divided by GDP averaged over 1998 – 2002. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. P_Catholic is the percentage of a country’s population belonging to Roman Catholic. Malaria is the percentage of the population at risk of contracting malaria. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Diversity Diversity Sqr Log(Per Capita GDP) Legal Origin FR Legal Origin UK Malaria Openness P_Catholic Continnent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) Expropriation Risk 667.3* (399.8) -499.0* (284.8) 1288.4*** (445.3) -946.9*** (316.6) 714.3*** (248.1) -522.1*** (176.8) 301.6* (166.4) -220.9* (119.4) 1.724*** 1.951*** 0.335** 0.648*** (0.214) 1.413** (0.631) 1.979*** (0.768) 0.308 (1.311) -2.023*** (0.591) -0.00345 (0.00805) (0.268) 1.682** (0.804) 2.931*** (0.972) -0.253 (1.572) -3.078*** (0.793) -0.00998 (0.00963) (0.139) 0.387 (0.427) 1.001** (0.467) -0.682 (0.735) -1.169*** (0.377) -0.00726 (0.00522) (0.117) -0.708** (0.308) 0.0242 (0.338) 0.104 (0.469) -0.230 (0.242) 0.000315 (0.00381) Yes Yes Yes Yes 94 0.584 93 0.638 102 0.304 108 0.690 0.669 0.680 0.684 0.682 48 Table 7 – Financial Development, Genetic Diversity, and Human and Social Capitals This table reports the regression of financial development on genetic diversity, its square, and controls, inclusion of proxies for human capital (Panel A) and social capital (Panel B). Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Openness is the sum of import and export divided by GDP averaged over 1998 – 2002. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. Malaria is the percentage of the population at risk of contracting malaria. School is the average years of schooling amongst the population. Social Inf is an index (ranging from 0 to 1) capturing the overall quality of institutions and government policies with a country. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Panel A Diversity Diversity Sqr Log(Per Capita GDP) Legal Origin FR Legal Origin UK Malaria Openness School Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 682.2* (397.6) -504.2* (283.0) 1092.4** (541.5) -800.4** (384.2) 527.8** (231.1) -386.7** (164.6) Expropriation Risk 316.8* (172.1) -233.0* (123.9) 1.560*** 1.857*** 0.102 0.470*** (0.241) 1.404** (0.700) 1.624** (0.797) 1.344 (1.302) -1.922*** (0.662) 0.191 (0.164) (0.371) 2.112** (0.940) 2.592** (1.072) 0.872 (1.739) -2.847*** (0.795) 0.350 (0.226) (0.185) 1.184*** (0.421) 1.660*** (0.473) -1.155 (0.967) -1.365*** (0.449) 0.303** (0.119) (0.149) -0.127 (0.369) 0.421 (0.355) 0.110 (0.562) -0.296 (0.301) 0.202** (0.0972) Yes Yes Yes Yes 79 0.624 79 0.652 83 0.456 92 0.705 0.677 0.682 0.682 0.680 49 Panel B Diversity Diversity Sqr Log(Per Capita GDP) Legal Origin FR Legal Origin UK Malaria Openness Social Inf Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) Expropriation Risk 768.9** (363.1) -555.2** (256.4) 1292.5*** (452.2) -929.1*** (320.0) 588.9** (237.0) -420.6** (168.5) 319.0** (156.1) -228.3** (112.0) 0.912** 1.035** 0.0296 0.359** (0.394) 0.232 (0.564) 0.630 (0.787) -0.510 (1.212) -1.757*** (0.516) 2.875 (1.842) (0.505) 0.191 (0.729) 1.183 (0.916) -1.578 (1.568) -2.996*** (0.723) 4.385* (2.434) (0.239) -0.0332 (0.380) 0.492 (0.491) -1.271 (0.782) -1.264*** (0.339) 2.074* (1.187) (0.146) -0.642** (0.295) -0.0448 (0.322) -0.199 (0.394) -0.327 (0.202) 3.009*** (0.860) Yes Yes Yes Yes 75 0.597 75 0.663 78 0.497 99 0.760 0.692 0.696 0.700 0.699 50 Table 8 – Financial Development and Alternative Measure of Genetic Diversity with Demand Proxy and Controls This table reports the regression of financial development on genetic diversity, its square, and controls, where genetic diversity is proxied by the 1500 CE-measure. Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Alt Diversity is the distance only based measure of predicted genetic diversity from Ashraf and Galor (2013), and Alt Diversity Sqr is its square. Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Openness is the sum of import and export divided by GDP averaged over 1998 – 2002. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. P_Catholic is the percentage of a country’s population belonging to Roman Catholic. Malaria is the percentage of the population at risk of contracting malaria. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Alt Diversity Alt Diversity Sqr Log(Per Capita GDP) Legal Origin FR Legal Origin UK Malaria Openness P_catholic Continent Dummies N Adj R2 Maximizing Level of Diversity Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) Expropriation Risk 427.3* (228.5) -338.9** (163.0) 653.3** (309.5) -514.7** (219.8) 282.3** (126.7) -226.3** (91.73) 45.27 (75.86) -45.27 (56.44) 1.561*** 1.779*** 0.281** 0.645*** (0.195) 1.731*** (0.579) 2.069*** (0.774) -0.151 (1.104) -2.022*** (0.594) 0.00129 (0.00762) (0.259) 2.102*** (0.739) 3.089*** (0.941) -0.973 (1.365) -3.105*** (0.689) -0.00472 (0.00884) (0.131) 0.550 (0.406) 1.073** (0.437) -1.021 (0.699) -1.186*** (0.350) -0.00541 (0.00513) (0.106) -0.659** (0.293) 0.114 (0.301) -0.00229 (0.449) -0.262 (0.227) 0.00220 (0.00389) Yes Yes Yes Yes 95 0.584 94 0.640 103 0.308 110 0.695 0.630 0.635 0.624 0.500 51 Table 9 – Financial Development and Genetic Diversity: Sub-sample Analysis This table presents the results of the effect of genetic diversity on each of the four financial development measures for each different sub-sample (Panels A-E) with the inclusion of Per Capita GDP and other controls. In Panel A of Table 8 we exclude the 30 OECD countries from our sample. Panel B reports the results where we omit 48 Sub-Saharan African countries. Panel C, D, and E reports the sub-samples where we omit the 10% of highest GDP per capital countries (Panel C), the 10% of lowest GDP per capital countries (Panel D), and both the 10% of highest and the 10% of lowest GDP per capita countries (Panel E). Log(Market Cap) is the logarithm of the average stock market capitalization over 1998 - 2002. Log(Stocks Traded) is the logarithm of the average total value of shares traded over 1998 - 2002. Log(Stocks Listed) is the logarithm of the average number of domestically listed companies over 1998 – 2002. Expropriation Risk is the risk of expropriation of investment averaged across 1985 – 1995. Diversity is the ancestry adjusted predicted genetic diversity in 2000 CE from Ashraf and Galor (2013), and Diversity Sqr is its square. Per Capita GDP is the per capita GDP averaged across 1998 - 2002. Openness is the sum of import and export divided by GDP averaged over 1998 – 2002. Legal Origin UK and Legal Origin FR are dummy variables for a country’s legal origin of English Common Law and French Civil Law, respectively. Malaria is the percentage of the population at risk of contracting malaria. Bootstrapped standard errors are reported in the parentheses. (*), (**) and (***) indicate the coefficients are statistically significant at the 10%, 5%, and 1% levels, respectively. Panel A Diversity Diversity Sqr Log(Per Cap GDP) Legal Origin FR Legal Origin UK Malaria Openness Continent Dummy N Adj R2 Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 667.1 (521.1) -495.7 (370.0) 1210.9** (574.6) -890.9** (410.4) 617.4** (260.3) -452.4** (185.9) Expropriation Risk 248.4 (177.9) -183.3 (128.2) 1.262*** 1.189** -0.0355 0.586*** (0.394) 2.450 (1.610) 2.509 (1.585) -0.291 (1.243) -1.416 (0.996) Yes 65 0.286 (0.472) 3.333* (1.899) 3.957** (1.725) -0.948 (1.587) -2.001* (1.166) Yes 64 0.411 (0.200) 1.196 (0.898) 1.387* (0.817) -1.005 (0.839) -0.585 (0.532) Yes 73 0.183 (0.195) -1.285** (0.612) -0.564 (0.553) 0.0820 (0.556) -0.177 (0.396) Yes 81 0.354 52 Panel B Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) Continent Dummy N 857.9** (430.8) -638.1** (308.8) 1.790*** (0.210) 1.305** (0.575) 1.994** (0.780) -0.636 (2.641) -1.899*** (0.575) Yes 81 1479.1** (599.7) -1084.9** (427.6) 2.048*** (0.306) 1.258* (0.750) 2.916*** (1.016) -0.907 (3.194) -2.903*** (0.726) Yes 80 670.7** (282.0) -489.7** (201.4) 0.362*** (0.136) 0.0286 (0.433) 1.043** (0.519) -0.546 (1.115) -1.092*** (0.388) Yes 89 Expropriation Risk 449.5** (177.1) -328.1** (127.5) 0.671*** (0.123) -0.675*** (0.262) 0.159 (0.351) 0.0891 (0.682) -0.283 (0.260) Yes 79 Adj R2 0.597 0.632 0.213 0.721 Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 628.9* (377.1) -472.6* (269.2) 1.673*** (0.230) 1.447** (0.681) 1.939** (0.842) 0.190 (1.177) -1.907*** (0.705) Yes 85 0.545 1221.3** (488.7) -898.6*** (347.8) 1.866*** (0.309) 1.728** (0.847) 2.892*** (1.031) -0.532 (1.465) -2.780*** (0.882) Yes 84 0.607 591.9** (256.9) -434.1** (182.9) 0.412*** (0.148) 0.376 (0.470) 1.038** (0.511) -0.860 (0.776) -1.083*** (0.410) Yes 92 0.326 Diversity Diversity Sqr Log(Per Cap GDP) Legal Origin FR Legal Origin UK Malaria Openness Panel C Diversity Diversity Sqr Log(Per Cap GDP) Legal Origin FR Legal Origin UK Malaria Openness Continent Dummy N Adj R2 53 Expropriation Risk 265.9 (176.1) -195.7 (126.6) 0.680*** (0.128) -0.857*** (0.317) -0.0908 (0.317) 0.147 (0.469) -0.275 (0.256) Yes 98 0.637 Panel D Diversity Diversity Sqr Log(Per Cap GDP) Legal Origin FR Legal Origin UK Malaria Openness Continent Dummy N Adj R2 Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 964.4* (502.1) -712.6** (358.5) 1.595*** (0.251) 1.514*** (0.549) 2.023** (0.809) -1.259 (1.654) -2.108*** (0.597) Yes 85 0.550 1711.0*** (548.5) -1250.8*** (392.0) 1.728*** (0.296) 1.922*** (0.709) 3.521*** (0.937) -2.273 (1.958) -3.370*** (0.772) Yes 84 0.617 833.5*** (287.4) -606.0*** (205.4) 0.208 (0.147) 0.241 (0.408) 1.082* (0.561) -1.346 (0.898) -1.320*** (0.420) Yes 92 0.259 Log(Market Cap) Log(Stocks Traded) Log(Stocks Listed) 934.6* (478.9) -693.1** (342.1) 1.520*** (0.285) 1.690** (0.696) 2.029** (0.968) -1.399 (1.642) -1.974*** (0.744) Yes 76 0.507 1660.1*** (637.2) -1216.0*** (454.8) 1.608*** (0.360) 2.318** (0.942) 3.623*** (1.194) -2.505 (2.073) -3.033*** (0.844) Yes 75 0.589 705.5** (285.6) -515.3** (203.9) 0.278 (0.172) 0.408 (0.468) 1.136* (0.582) -1.463 (0.957) -1.226*** (0.444) Yes 82 0.283 Expropriation Risk 449.7*** (174.3) -328.5*** (125.3) 0.694*** (0.117) -0.688*** (0.249) 0.147 (0.298) 0.215 (0.474) -0.286 (0.232) Yes 98 0.720 Panel E Diversity Diversity Sqr Log(Per Cap GDP) Legal Origin FR Legal Origin UK Malaria Openness Continent Dummy N Adj R2 54 Expropriation Risk 412.5** (184.2) -302.1** (132.8) 0.738*** (0.117) -0.867*** (0.303) 0.0450 (0.350) 0.269 (0.500) -0.342 (0.263) Yes 88 0.674 Table 10 – Variable Description and Data Source Market Cap Stocks Traded Stocks Listed Expropriation Risk Diversity Alt Diversity Legal FR Legal UK P_catholic Openness Per Capita GDP Malaria School Social Inf Stock market capitalization in billion dollars averaged across 1998 – 2002; Source: World Bank Global Financial Development Database Total value of shares traded in billion dollars averaged across 1998 – 2002; Source: World Bank Global Financial Development Database Total number of domestically listed companies on the country’s stock Exchanges averaged across 1998 – 2002; Source: World Bank Global Financial Development Database Average Protection against expropriation risk, average of 1985-1995 - ranges from 0 to 10 with higher numbers meaning more protection and less risk; Source: Acemoglu et. al. (2001) Ancestry adjusted measure of predicted genetic diversity in 2000 CE; Source: Ashraf and Galor (2013) Migratory distance only predicted measure of genetic diversity; Source: Ashraf and Galor (2013) Dummy variable for a country’s legal origin of French Civil Law; Source: Ashraf and Galor (2013) Dummy variable for a country’s legal origin of English Common Law; Source: Ashraf and Galor (2013) Percentage of a country’s population belonging to Roman Catholic; Source: Ashraf and Galor (2013) Sum of import and export divided by GDP averaged across 1998 – 2002; Source: World Bank Open Data Per capita GDP averaged across 1998 – 2002; Source: World Bank Global Financial Development Database Percentage of the population at risk of contracting malaria; Source: Ashraf and Galor (2013) Average years of schooling amongst the adult population from reports of Barro and Lee (2001); Source: Ashraf and Galor (2013) An index between 0 and 1 that measures the quality of the social institutions and Government policies, calculated by Hall and Jones (1999); Source: Ashraf and Galor (2013) 55