City Size and Financial Development

Bo Becker

No 46, SIFR Research Report Series from Institute for Financial Research

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

Keywords: City size; agglomeration economies; financial development (search for similar items in EconPapers)
JEL-codes: G10 G20 O16 R10 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2006-09-15
New Economics Papers: this item is included in nep-fin, nep-geo and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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