The dynamics of bond market development, stock market development and economic growth

Rudra P Pradhan,Sahar Bahmani,Mak B Arvin,Neville R Norman

doi:10.1108/jefas-09-2018-0087

Abstract

Purpose The paper investigates whether Granger causal relationships exist between bond market development, stock market development, economic growth and two other macroeconomic variables, namely, inflation rate and real interest rate. The study aims to expand the domain of economic growth by including a more in-depth analysis of the possible impact that bond market and stock market development has on economic growth than is normally found in the literature. Design/methodology/approach This paper uses a panel data set of the G-20 countries for the period 1991-2016. It uses a panel vector auto-regression model to reveal the nature of any Granger causality among the five variables. Findings The paper provides empirical insights that both bond market development and stock market development are cointegrated with economic growth, inflation rate and real interest rate. The most robust result from the panel Granger causality test is that bond market development, stock market development, inflation rate and real interest rate are demonstrable drivers of economic growth in the long run. Research limitations/implications Because of the chosen research approach, the research results may lack theoretical foundations. Therefore, perhaps the more fully grounded interactive findings of this study can inspire theorists to fill the missing gap. Practical implications This paper includes lessons for policymakers in the G-20 countries seeking to stimulate economic growth in the long run and how they need to ensure greater stability of the interest rate and inflation rate as well as fully developing their financial markets, as both bond markets and stock markets are obvious drivers of economic growth. Originality/value This paper fulfills an identified need to study causal relationships between bond market development, stock market development, economic growth and two other macroeconomic variables, i.e. inflation rate and real interest rate.

Highlights

There is widespread argument that well-developed financial markets play a key role in promoting economic growth
Notes: GDP: Per capita economic growth; BMD: Bond market development index; SMD: Stock market development index; INF: Inflation rate; and RIR: Real interest rate; LLC: Levin-Lin-Chu statistics; ADF: Augmented Dickey–Fuller statistics; PP: Phillips–Perron statistics; the null hypothesis is that the variable follows a unit root process; *indicates significance at the 1% level; methods used are based on Levin et al (2002); Maddala and Wu (1999) Source: Authors’ calculations critical values for all the approaches, the null hypothesis of unit root at the 1 per cent significance level is rejected so that the variables are integrated of order one. These results reveal that there is the possibility of cointegration among per capita economic growth, bond market development, stock market development, inflation rate, and real interest rate
Using panel data of the G-20 countries from 1991 to 2016, we found that both bond market development and stock market development are cointegrated with economic growth, inflation rate, and real interest rate

Summary

Introduction

There is widespread argument that well-developed financial markets play a key role in promoting economic growth (see, for instance, Adeniyi et al, 2015; Capasso, 2008; Jedidia et al, 2014; Levine, 1997; Otchere et al, 2016; Pradhan et al, 2015; Uddin et al, 2013; Wachtel, 2001). Several studies[2] provide supporting evidence that financial development contributes to economic growth (see, for instance, Pradhan et al, 2014a, 2014b, 2014c). Many of these studies focus on the overall development of financial markets with little to no attention being given to the development of either stock markets or bond markets[3]. The research on the relationships between bond market development and economic growth is scarce in the growth and financial literature alike (Egert, 2015; Mu et al, 2013; Sharma, 2001)

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Conclusion