Global Growth Opportunities and Market Integration

We propose an exogenous measure of a country’s growth opportunities by interact-ing the country’s local industry mix with global price to earnings (PE) ratios. First, we find that these exogenous growth opportunities strongly predict future changes in real GDP and investment in a large panel of countries. This relation is strongest in countries that have liberalized their capital accounts, equity markets, and banking systems. Second, we re-examine the link between financial development, external fi-nance dependence, investor protection, capital allocation, and growth. We find that financial development, external finance dependence, and investor protection measures are much less important in aligning growth opportunities with growth than is capital market openness. Third, we formulate new tests of market integration and segmen-tation. Under integration, the difference between a country’s local PE ratio and its global counterpart should not predict relative growth, but the difference between its ex