A recent extension of the "financial deepening" literature has been to incorporate the stock market as a measure of financial development. Besides the historical focus on banking, there is an expanding theoretical literature on the links between the stock market development and economic development. The global growth of stock markets and the emerging market boom have attracted the attention of academics, practitioners, and policymakers. However, the growth impact of stock market liberalization continues to be intensely debated. Each theoretical model in the literature focuses on one characteristics of the functioning of stock markets such as market size, liquidity or integration (Atje and Jovanovic, 1993; King and Levine, 1993; Devereux and Smith, 1994; Obstfeld, 1994; Bencivenga et al. 1995; Levine and Zervos, 1998; Beck et al. 2000; Levine et al. 2000).
Although there is considerable empirical and theoretical literature that postulates a positive first order relationship between the stock market development and economic growth, it is somewhat surprising that empirical studies which attempt to establish causality by undertaking Granger-causality tests are few and far between. Demetriades and Hussein (1996) conducted causality tests and found little evidence that financial sector development causes economic growth. They found that causality patterns varied across countries. Toda and Yamamoto (1995), to test for causality in VARs, examined the linkage between the stock market development, bank development, and economic growth and emphasized the possibility of omitted variable bias. Caporale et al. (2004) obtained evidence from a sample of seven countries suggests that a well-developed stock market can foster economic growth in the long-run. |
