Abstract
Contemporaneous correlation coefficients between per capita growth and market capitalization to GDP ratio calculated for 35 countries reveal highest correlations for emerging economies. The paper explains this phenomenon in an extended Lucas (Econmetrica 46(6):1429–1445, 1978) asset pricing model with production, accumulation and growth with two separately added additional features, international borrowing by domestic firms and holding of domestic shares by foreign agents. It is shown that in the first scenario, growth enhancing productivity shock increases market capitalization ratio in the short run and in the second, a positive demand shock increases short run growth. The model is calibrated using quarterly Indian data.
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