The rules of the game and the development of security markets

Abstract

A stable legal rule and its consistent enforcement is indispensible for affective private contracting. The ability to bind oneself through a credible contractual obligation to future action facilitates economic transactions and promotes private incentive to invest. Therefore, a credible legal rule is a public good. However, its elaboration and enforcement relies on deliberate government actions. When government policy is not sufficiently stable and committed to a set of "rules of the game," an inadequate or arbitrarily enforced legal rule encourages private efforts to obtain favorable treatment, thus weakening the credibility of the transacting mechanism. Transactions will tend to become noncontractual, and trade will be limited to agents bound by private enforcement mechanisms. The lack of active and videspread market participation means the loss of the beneficial effect of efficient market trading and of the diffusion of information through market price determination, and the inefficient allocation of risks.