The Quarterly Review of Economics sod Finance, Vd. 37, No. 2, Summer 1997, pages 51 l-522 Copyright Q 1997 Tkustees of the University of Illinois All rights of mproduction in any form nservcd ISN 1662.9769 Price Effects of Stock Market Liberalization in Taiwan FELIX B. KWAN MARIO G. REYES University of Idaho In January, I991, I/2e Taiwan stack market was pa&u’ly opened to direc! investment br foreign investors. This paper examines the stork price effeeds of this market liberalrtiion. We use the GARCH methadology to tnvesligab the rmpacl of stock-ma&l liberalarolion on the distn&utum of stock relums y&&d by !he Tatwan Weighied Index over the period, 1988-1994. Thp w&/c show that Taiwan’s stock market liberalizattan has indrrred some changes in the returns distnbu- lion. More importantly, the volairliryof s/ock returns ts lower posl-liberalizution. Neoclassical economics points to free markets as a nation’s best approach toward economic development. Liberalization and privatization have been widely hailed as important elements in a proper strategy to achieve stronger economic growth (Todaro, 1994, pp. 8586). But is this free-market approach applied to stock markets good for a developing country? One of the controversial issues in the economic-development literature concerns the merits of an expanded role for stock markets-particularly liberalized ones-as a source of investment funds in developing countries. Drake (1986) and Singh (1993) provide a very good survey of the two sides of this issue. On one hand, the benefits of having an active liberalized stock market include the following: (a) it helps fill gaps in the availability of savings for domestic investment requirements; (b) it facilitates a more efftcient allocation of investment resources; (c) it helps foster discipline among corporate managers; and (d) it allows a lesser dependence on debt-financing, hence it also leads to a reduced vulnerability to interest-rate increases (Mullin, 1993). On the other hand, an economy’s heavy reliance on the stock market for its investment funds could expose the economy to such threats as: (1) a lack of the long-term commitment required for stability in real fixed investments; (2) a weakened ability for the government to pursue its industrial-development poli- cies; and (3) an increased susceptibility to speculation and economic or political 511