Stock Markets, Banks and Economic Growth: Some Evidence on the Role of Stock Price Informativeness

Abstract

This paper extends the economic growth model tested by Levine and Zervos (1998) by including a measure for capital allocation efficiency proxied by stock price informativeness. Using a sample of 59 countries, this study finds that stock price informativeness as measured by firm-specific return variation is positively associated with economic growth after controlling for variables in the Levine and Zervos’s (1998) model. However, when we split the countries into emerging versus developed countries, we find that stock price informativeness acts as a substitute for banking development and stock market liquidity in predicting economic growth in emerging countries but not in more developed countries. These results are consistent with the Roll’s (1988) claim: more information-laden stock prices signal efficient stock markets and, therefore, stronger economic growth.