Abstract
This study investigated the causal relationship bet ween stock market development and economic growth for Greece for the period 1978-2007 using a Vector Error Correction Model (VECM). Questions were raised whether stock market development causes economic growth taking into account the negative effect of interest rate on stock market development. The p urpose of this study was to investigate the short-r un and the long-run relationship between the examined vari ables applying the Johansen co-integration analysis . To achieve this objective unit root tests were carried out for all time series data in their levels and t heir first differences. Johansen co-integration analysis was a pplied to examine whether the variables are cointegrated of the same order taking into account th e maximum eigenvalues and trace statistics tests. Finally, a vector error correction model was select ed to investigate the long-run relationship between stock market development and economic growth. A short-run increase of economic growth per 1% induced an increase of stock market index 0.41% in Greece, whi le an increase of interest rate per 1% induced a relative decrease of stock market index per 1.42% i n Greece. The estimated coefficient of error correc tion term was statistically significant and had a negati ve sign, which confirmed that there was not any pro blem in the long-run equilibrium between the examined variables. The results of Granger causality tests indicated that there is a unidirectional causality between stock market development and economic growth with direction from economic growth to stock market development and a unidirectional causal relationsh ip between economic growth and interest rate with dire ction from economic growth to interest rate. Therefore, it can be inferred that economic growth has a direct positive effect on stock market develo pment while interest rate has a negative effect on stock market development and economic growth respectively.
Highlights
Stock market development has been the subject of intensive theoretical and empirical studies (DemirgucKunt and Levine, 1996; Levine and Zervos, 1998)
This study investigated the causal relationship between stock market development and economic growth for Greece for the period 1978-2007 using a Vector Error Correction Model (VECM)
It can be inferred that economic growth has a direct positive effect on stock market development while interest rate has a negative effect on stock market development and economic growth respectively
Summary
Stock market development has been the subject of intensive theoretical and empirical studies (DemirgucKunt and Levine, 1996; Levine and Zervos, 1998). Stock market contributes to the mobilization of domestic savings by enhancing the set of financial instruments available to savers to diversify their portfolios providing an important source of investment capital at relatively low cost. A well functioning and liquid stock market, that allows investors to diversify away unsystematic risk, will increase the marginal productivity of capital (Pagano, 1993). Another important aspect through which stock market development may influence economic growth is risk diversification. Obstfeld (1994) suggests that international risk sharing through internationally integrated stock markets improves the allocation of resources and accelerates the process of economic growth Another important aspect through which stock market development may influence economic growth is risk diversification. Obstfeld (1994) suggests that international risk sharing through internationally integrated stock markets improves the allocation of resources and accelerates the process of economic growth
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