THE EFFECTS OF FINANCIAL MARKETS ON PRIVATE CAPITAL FORMATION: AN EMPIRICAL ANALYSIS OF TURKISH DATA OVER 1968-1998 PERIOD

Lütfi Erden (Mersin University)

Although the neoclassical investment theory postulates that the private investment is strongly related to the cost of capital, empirical studies have indicated a weak and often insignificant link between the two. There are two potential reasons for this identified in the literature. One argument is that the availability of credits may be more binding than the costs in developing countries because of their institutional and structural characteristics. The other is that the uncertainty surrounding the cost of capital may have a more substantial impact on private investment than the level of cost. Given these arguments, this paper investigates the question of whether the cost, quantity of credits, and/or cost uncertainty stemming from financial markets play a more important role in determining private investment in a developing country such as Turkey. To this end, this study modifies the neoclassical investment model to include credit availability and an appropriate measure of cost uncertainty obtained by fitting a univariate GARCH process of real interest rate. While reinforcing the findings of previous studies that the quantity of credits significantly affects private investment, the results goes on to indicate that cost uncertainty, but not the level, has an adverse impact on private investment in Turkey.