What Makes Markets Work: A Structural Analysis of Political Attributes Driving Capital Market Strength Across Regimes

Abstract

This study examines the political and institutional determinants of capital market strength across democratic and autocratic regimes. While existing literature often contrasts regime type in isolation, this research integrates governance quality and regime classification within a unified empirical framework to assess their relative and interactive effects on market development. Using a panel dataset of 11 countries, both advanced and emerging, observed between 2014 and 2024, the analysis evaluates how institutional variables drawn from the World Governance Indicators influence capital market depth and resilience.

Two dependent variables are employed: the log of stock market capitalisation relative to GDP as a measure of market depth, and a newly constructed Composite Strength Market Index (CSMI) capturing size, liquidity, and stability. Panel regression techniques with clustered standard errors are applied to test four hypotheses concerning the roles of rule of law, regulatory quality, state capacity, regime type, and macroeconomic fundamentals.

The findings demonstrate that governance quality, particularly rule of law and regulatory quality, is positively associated with capital market development. Economic size, proxied by GDP, emerges as a strong predictor of market depth. Regime type alone is not a statistically significant determinant once institutional quality is controlled for. Interaction analysis reveals that democratic accountability strengthens market outcomes within democracies, while in autocracies, state capacity and institutional effectiveness can partially substitute for democratic mechanisms. Across both regime types, political stability significantly enhances market resilience.

Overall, the results suggest that capital market strength depends less on regime classification and more on institutional soundness, legal protections, and policy consistency. Effective governance, rather than political ideology alone, forms the structural foundation upon which resilient financial markets are built.