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.
