Examining the Impact of Stock Market Development on Economic Growth: Dynamic Panel Evidence from Emerging Market Economies

Abstract

This study empirically reexamines the impact of stock market development on economic growth using data on twenty-seven emerging market economies over the period 1995-2012. We use market capitalization, trade value and turnover ratio as indicators of stock market development. Also, we construct three alternate composite indices of stock market development and used them in the growth regression each at a time. Methodologically, we employ the dynamic panel ‘system GMM’ estimators which is free from the problem of endogeneity and measurement errors; secondly, a 2nd generation panel unit root test of Pesaran (2007) is employed to test the stationary properties of data; finally, in order to test the direction of causality we make use of a newly developed panel non-causality test of Dumitrescu and Hurlin (2012) which is designed for heterogeneous panel. Our empirical findings indicate that stock market development significantly contributes to economic growth. This is evident in all the three alternate indices of financial development employed in the study. Further, we find a unidirectional causation running from stock market development to economic growth, supporting the supply-leading hypothesis. We also find that macroeconomic variables, such as investment ratio, trade openness and exchange rate have strong influence on economic growth. Thus, the study suggests that significant improvement of stock markets, making the economy internationally open, and improving the aggregate investment the emerging market economies can improve their economy.