STOCK MARKET DEVELOPMENT AND ECONOMIC GROWTH: EVIDENCE FROM BOOTSTRAP PANEL GRANGER CAUSALITY TEST

Abstract

The paper presents causality analysis between stock market development and economic growth for 25 advanced economies over the period 1975-2011. We apply bootstrap panel Granger causality method (Emirmahmutoglu and Kose, 2011) for this purpose, which incorporates heterogeneity and cross-sectional dependence in a panel framework. Using alternative measures of stock market size and liquidity, we find evidence of uni-directional causality from stock market development to growth in case of individual countries as well as with panel statistics in the presence of cross-sectional dependence which support supply leading hypothesis (stock market led growth). However, we hardly find any evidence of demand-following hypothesis or feedback hypothesis. Findings also reveal that market size is relatively more important than liquidity measures in case of advanced economies despite favourable theoretical prediction that stock market liquidity might ease investments, improve allocation of capital and enhance prospects for economic growth. Probable policy implications that emerge from experiences of advanced economies is that despite several unfavourable features of stock market development, which put certain market dominated advanced economies in disadvantageous positions compared to certain bank-based economies, emerging economies should certainly focus on stock market development as alternative potential means of financial development and hence long-term economic growth.