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Proceedings of 6th International Business and Social Sciences Research Conference

3 – 4 January, 2013, Dubai, UAE, ISBN: 978-1-922069-18-4




A.E.Osuala (PhD)1

Department of Banking and Finance,

College of Management Sciences,

Michael Okpara University of Agriculture, Umudike, Nigeria.

Email: Osuala.alex@mouau.edu.ng; Tel: 2348030606878 J.E.Okereke (PhD)2 Department of Banking and Finance, University of Port Harcourt, Rivers State, Nigeria G.U.Nwansi,3 Department of Banking and Finance, Federal Polytechnic, Nekede, Owerri, Imo State, Nigeria Abstract This paper examines the existence of causality relationship between stock market performance and economic growth in Nigeria using Granger causality test. Time series data on economic growth, proxied by Gross Domestic Product (GDP), and stock market performance indicators, such as market capitalization ratio (MCAPR), turnover ratio (TOR) and total number of deals ratio (TNDR) derived from the central bank of Nigeria (CBN) statistical bulletin, Vol. 20, 2009 and National Bureau of Statistics (NBS) official website, were used. The study finds the empirical evidence of long-run co-integration between economic growth and stock market performance. However, with regard to causal relationship between GDP and Stock market performance indicators, unidirectorial causality was established from MCAPR and TNAR to GDP only on the longrun. On the short-run, there was no causal relationship between economic growth and stock mark performance. Furthermore, the impact of the stock market on economic growth was found to be negative and non-significant at 5% level. This is quite understandable because the unethical practices and the subsequent crash in the stock market have undermined the potentials of the market in enhancing economic growth in Nigeria. The study therefore recommends that the regulatory authorities should initiate policies that would rekindle the dwindling interest and confidence of both domestic and foreign investors in the market, and also be more proactive in their surveillance role in order to checkmate negative practices which undermine market integrity.

Keywords: Stock market, economic growth, causality investigation, stationari

–  –  –

1. Introduction It is well acknowledged in academic literature that an efficient and well-developed financial system is important for influencing economic growth. The positive effects of financial development on growth are basically credited to the functions it plays particularly in the mobilization and allocation of resources needed to undertake productive investment activities by various economic agents. Theoretical literature argue that the increased availability of financial instruments and institutions greatly reduces transaction and information cost in the economy which in turn influences savings rate, investment decisions and undertaking of technological innovations. A large number of empirical works (e.g King and Levine, 1993;

Levine, 1997; Neusser and Kugler, 1998; Beck, Levine and Loayza, 2000; Odedokun, 1996; Abma and Fase, 2003; etc) have also tested the finance-growth relationship employing different methodological techniques and using different indicators of financial development in CrossCountry or time series studies. The empirical findings, mostly in the developed markets, are generally in consensus that a well- functioning and efficient financial system has beneficial impacts on economic growth (Islam) and Osman, 2005).

Most of the existing studies based on the developed countries experiences have used three sub sectors of the financial system in the finance-growth nexus literature as proxy for financial development or growth, namely, the banking sub sector, the capital market and the non-bank financial intermediaries. Most of the studies in particular indicate that the developed economies had explored two particular channels through which resources mobilization affects economic growth and development - money and capital markets (Samuel, 1996; Demirguc Kunt and Levine, 1996). This is not however the case in developing economies where emphasis was placed on money market with little consideration for capital market (Nyong, 1997; Osinubi, 2000).

Since the introduction of Structural Adjustment Programme (SAP) in Nigeria in 1986, the country’s stock market has grown very significantly (Nile, 1996; Soyode, 1990). This is as a result of the deregulation of the financial sector and the privatization exercises, which exposed investors and companies to the relevance of the stock market. Equity financing became one of the cheapest and flexible sources of finance from the capital market and remains a critical element in the sustainable development of the economy (Okereke – Onyiuke, 2000).

Although the liberalization of the capital market led to the growth of the Nigerian stock market, it is said that the growth impact at the macro-economic level was negligible (Ariyo and Adelegan, 2005). The role of the stock market in economic development is primarily to channel capital into businesses. The continuous flow of capital gives businesses the liquidity they need to work and expand thereby stimulating economic growth and development.

If however, the growth of the stock market is not exerting corresponding impact at the macroeconomic level, then it calls to question the popular opinion that stock market growth engenders national economic growth. In fact, it has been argued that there exists very little Proceedings of 6th International Business and Social Sciences Research Conference 3 – 4 January, 2013, Dubai, UAE, ISBN: 978-1-922069-18-4 hard empirical evidence on the impact of stock markets development on long- run economic growth, and even yet fewer for developing countries (Mohtadi and Agarwal, 2004).

A much more pertinent concern is the exploration of the direction of influence or causality between stock market development and economic growth. This has been furiously debated with respect to the developed markets; but on the part of the developing markets some have argued that there is no correlation between these two variables, and any seemingly comovement is seen as contemporaneous (Lucas, 1998).

Given that the stock market provides some services as earlier mentioned, that ginger economic

growth, this study aims at:

1. Empirically investigating whether the stock market really promotes economic growth in Nigeria using Ordinary Least Square (OLS) method on secondary data covering the period 1990-2010, and

2. Determining the direction of causality between stock market development and economic growth.

The remaining part of the study is organized as follows. Section two reviews the literature.

Section three provides the methodology while section four deals with empirical analysis.

Section five concludes the study with summary and recommendations.

2. Literature Review

2.1 Correlation between the stock market and economic growth: The theoretical Nexus There has been a growing interest and studies on the impact of stock market development on economic growth. This growing concern according to Rouseau and Wachtel (2000) is due chiefly for four reasons. First, an equity market provides investors and entrepreneurs with a potential exit mechanism. This opinion or argument is hinged on the fact that venture capital investments will be more attractive in countries where an equity market exists than one without an adequately functioning public equity market. And when the market exists, the venture capital investor knows that it is possible to realize the gains from a successful project when the company values an initial public offering. The option to exit through a liquid market mechanism makes venture capital investments more attractive and might well increase entrepreneurial activity generally. The impact of the market will be felt then well beyond the firms that actually do use the market for raising capital and this will positively impact on the growth of the national economy. (Riman, et al, 2008; Benchivenga and Smith, 1991).

Secondly, capital inflows - both foreign direct investment and portfolio investments, are potentially important sources of investment funds for emerging market and transition economies. The existence of equity markets facilitates capital inflows and the ability to finance Proceedings of 6th International Business and Social Sciences Research Conference 3 – 4 January, 2013, Dubai, UAE, ISBN: 978-1-922069-18-4 current account deficits and to give domestics businesses the liquidity they need to work with and expand.

Thirdly, the provision of liquidity through organized exchanges encourage both international and domestics investors to transfer their surpluses from short-term assets to the long-term capital market, where the funds can provide access to permanent capital for firms to finance large, indivisible projects that enjoy substantive scale economies, and this will ultimately have implication on national economic development.

Finally, the existence of a stock market provides important information that improves the efficiency of financial intermediation generally. This has the effect of lowering transaction cost, increasing sayings and investments, and thereby engendering economic growth.

According to Nieuwerburgh et al (2005), financial markets facilitate pooling and trading of risk.

In the absence of this service, investors facing liquidity shocks are forced to withdraw funds invested in long-term investment projects. Such early withdrawal reduces economic growth.

The stock market makes it easy for liquidity risk that individual investors face at the aggregate level to be perfectly diversified. By facilitating diversification, the market allows the economy to invest relatively more in productive technology. This spurs economic growth (Diamond and Dybvig, 1983; Greenwood and Smith, 1997; Obstfeld, 1994).

2.2 Cross-Country Econometric Evidence of Stock Market Impact on Economic Growth

There is substantial Cross-Country evidence that tend to suggest that countries with a better developed stock market and banking system witness higher subsequent growth. The idea that financial development matters for growth in the early stages of economic development goes back to Patrick (1966), Cameron (1967) and Goldsmith (1969). In his study, Goldsmith (1969) establishes the important fact that periods of above average rates of economic growth tend to be accompanied by faster financial development. King and Levine (1993) document a robust relationship between initial levels of financial development and subsequent economic growth across 80 countries, after controlling for other growth –inducing factors. Rousseau and Sylla (2001) also employ a Cross-Country regression framework to make the case for finance-led growth. In their study, the employ a long data set covering the period: 1850 – 1997, for the Netherlands, and affirm that financial development leads to economic growth, especially at the early stage of development. Levine and Zerves (1998) conducted a similar analysis for 48 countries and for the period: 1976 – 1993, but focused primarily on the role played by the stock market. They measured stock market development along various dimensions: size, liquidity, international integration and volatility. More precisely, their measures were aggregate stock market capitalization to GDP and number of listed firms (size), domestic turnover and value traded (liquidity), with world capital markets, and the standard deviation of monthly stock returns (Volatility). The results of the study suggest a strong and statistically significant relationship between initial stock market development and subsequent economic growth. In fact in emphasizing the strong impact of the stock market development on national economic Proceedings of 6th International Business and Social Sciences Research Conference 3 – 4 January, 2013, Dubai, UAE, ISBN: 978-1-922069-18-4 growth, Atje and Jovanovic (1993) reported that in their study where both stock market development and bank development were introduced as regressors in the regression model, stock market development was found to have a greater effect than bank development on subsequent growth rate.

Rousseau and Wachtel (2000) added a time dimension, and studied the link between equity markets and growth for 47 countries between 1980 –1995 in a dynamic panel setting. They emphasized the importance of liquidity of stock markets for economic growth.

Spears (1991), Pardy, (1992) and Pandel (2005) are all of the opinion that there exist long-run positive correlation between stock market development and economic growth, even in developing countries.

However, the traditional growth theorist such as Singh (1997), Singh and Weis (1999) believed that stock market development does not have any beneficial effect on economic growth. Singh (1997) in particular argued that stock markets are not necessary institutions for achieving high levels of economic development.

Stiglitz (1985), for example, questioned the role of stock markets in improving informational asymmetries, and argued that stock market reveal information through price changes rapidly, thereby creating a free-rider problem that reduces investor incentive to conduct costly search.

On the argument regarding the contribution of stock market liquidity to long-run economic growth, Demirguc –Kunt and Levine (1996) posit that increased liquidity may deter growth via three channels. First, it may reduce saving rates through income and substitution effects.

Second, by reducing the uncertainty associated with investments, greater stock market liquidity may reduce saving rates because of the ambigous effects of uncertainty on savings. Third, stock market liquidity encourages investors’ myopia, adversely affecting corporate governance and thereby reducing economic growth.

Our position in this stock market – economic development controversy is to take a middle of the road stand and then empirically investigate this suggested relationship for evidence either in support of, or against this purported correlation.

2.3 Stock Market and Economic Growth – The Causal Test Lately, there has been a paradigm shift from whether stock market development engenders economic growth to the direction of causality between stock markets and economic growth.

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