Credit for equity investment and stock market volatility: evidence of variance causality

Abstract

This paper investigates the causal relationship between stock market price changes and banks' loans for equity investment in Saudi capital markets using Granger's causality test and cross-correlation function (CCF) of standardised residuals. The findings in the paper show that the mean causality between the two capital markets is insignificant whereas the variance causality is significant. This result implies that the effect of news transmission between the two markets has no significant impact on these markets, but there is significant evidence of volatility transmission between the two markets. This means that public information (or news) held by the market participants has insignificant impact on stock price change but unexpected shocks on either market have significant spillover effects. A policy implication of such finding is that to contain irregular surprise shocks on Saudi stock market it is required stronger surveillance on portfolio managers' speculative and manipulative behaviour.