The impact of stock market returns on economic growth in nigeria
Ovat Department of Economics, University of Calabar, Calabar Nigeria. Stock Market Development and Economic Growth in Nigeria: Market Size Versus Liquidity.
This study investigates empirically into the acclaimed positive role played by stock markets in driving growth, with evidence from the Nigerian stock market. Stock market size and stock market liquidity. The essence is to know the aspect of stock market development that is the main driver of growth in Nigeria. The findings suggest the dominance of stock market liquidity over market size. While there is a two way causation between stock market liquidity and economic growth with the strength of the causality coming more from stock market liquidity, market size is found to have little or no effect on growth.
Equally the results suggest a one way causation between financial deepening and growth with causality flowing from financial depending to economic growth. Stock market size ; L iquidity ; E conomic growth ; C ausality ; Nigeria. Canadian Social Science , 8 5 , 71 - It is widely acclaimed by development economists and policy makers that a well developed stock market is crucial for the mobilization of financial resources for long term investment and thus constitutes one of the major pillars of economic growth.
In principle, the stock market is expected to accelerate economic growth by providing an avenue for growing companies to raise capital at lower cost. Countries with developed stock markets provide alternative sources of financing to companies there by making them less dependent on bank financing, which in turn mitigate the risk of credit crunch.
In recognition of the acclaimed catalytic impact of developed stock markets on economic growth, a plethora of studies now focus on the relationship between stock market development and economic growth. Furthermore, in addition to the aforementioned limitations, previous studies such as those of Nyong , Levine and Zervos , Ogun and Iyoha use a single composite measure of stock market development as opposed to a variety of measures and document a positive and significant correlation between stock market development and long - run growth.
The use of cross-sectional approach by Levine and Zervos and a single composite measure of stock market development in Nigeria by Nyong , and Ogun and Iyoha , constitutes serious empirical limitations on the robustness of their results for policy action. The use of a variety and disaggregated measures of stock market development would have provided a richer and clearer picture of the potential links between stock markets and growth, thus showing clearly the aspect of stock market development that is the main driver of growth.
The determination of whether it is stock market size or stock market liquidity via their indicators that is the appropriate channel through which stock markets influence growth is important for policy direction. This study therefore sets to address the short coming and lacuna created by previous studies by adopting various indicators of stock market development to determine which indicator is the best channel through which growth is driven by the stock market in Nigeria.
The rest of the paper is organized as follows: Section 2 reviews empirical literature, section 3 outlines the methodology. In section 4, empirical results are presented and discussed. Finally, section 5 provides the summary and concluding remarks of the study. Empirical literature and theoretical issues.
Empirical investigations of the link between stock market development and economic growth have been relatively limited in developing countries, especially Nigeria. Theoretically, the relationship has been a subject of controversy. Previous studies carried out have hardly come to a unanimous conclusion on the causal linkage between stock market development and economic growth.
While some studies maintain that stock market development vigorously drives growth others are of the view that it retards growth. For example, Singh is of the view that stock market accelerates economic growth by providing a boost to domestic savings and increasing the quantity and quality of investment. It is also argued that stock market liquidity the ease and speed with which agents can convert assets into purchasing power at agreed prices plays crucial role in the process of economic growth.
Stock market liquidity reduces the downside risk and costs of investing in projects that do not pay off except for a long time. With a liquid market, the initial investors do not lose access to their savings for the duration of the investment project because they can easily and quickly sell their stake in the company. In the same vein, Hicks emphasizes vehemently that the critical ingredient that ignited growth in eighteenth century England was capital market liquidity.
THE IMPACT OF STOCK MARKET PERFORMANCE ON THE GROWTH OF NIGERIAN ECONOMY | Donexbefree Abdul - uqyhadet.web.fc2.com
He argues that by creating the mechanisms for easy trading of equity, capital markets facilitate growth. This is because liquid markets provide firms with permanent access to long term capital as they facilitate the ease of buying and selling securities. He further submits that the industrial revolution in Europe was not due principally to a set of new technological innovations but the existence of liquid capital markets.
To this end, the industrial revolution had to wait for the revolution in English financial market Bencivenga et al. Grossman and Stiglitz , and Kyle also comment on the issue of stock market liquidity. They maintain that liquid stock markets may lead to an improvement in corporate governance through the incentives it offers investors to acquire better information about firms which in turn lead to efficient resources allocation and hence promotes economic growth.
Ogun and Iyoha , using the Granger causality model document a significant relationship between current level of real gross domestic product and lagged value of stock market capitalization in Nigeria for the period They concluded that stock market promotes economic activity and as such could be relied upon as a predictor of economic activity in Nigeria. In like manner, Nyong develops an aggregate index of capital market development and use it to determine its relationship with long run economic growth in Nigeria.
His findings show that capital market development is significantly correlated with long - run growth. Also there exists a bi-directional causality between capital market development and economic growth. Saint-Paul , Devereux and Smith , Obstefeld are also of the view that stock market promotes economic growth through risk diversification and international integration of stock markets.
They argue that through greater diversification, stock markets influence growth by shifting investment into higher return projects.
Again, Filer et al use Granger causality test to show that there exists a causal relationship between stock market development and economic growth, the direction of causation flowing from stock market to economic growth. Similarly, Mohtadi and Agarwal examine the relationship between stock market development and economic growth for 21 emerging markets over 21 years, using a dynamic panel method.
Results suggest a positive relationship between several indicators of the stock market performance and economic growth both directly, as well as indirectly by boosting private investment behaviour. Their results show that stock market development is positively correlated with economic growth with feed back effect, but the stronger link is from economic growth to stock market, suggesting that financial development follows economic growth. The alleged positive linkage between stock market development and economic growth is seriously refuted by some economists.
Critics of the stock market argue that well functioning stock markets may adversely affect growth.
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For example the contribution of stock market liquidity to long - run economic growth has been questioned by Demirguc - Kunt and Levine They maintain that increased liquidity can influence growth negatively via three channels. Firstly, by increasing the returns to investment, greater stock market liquidity may reduce savings rates through income and substitution effects. Secondly, by reducing the uncertainty associated with investments, greater stock market liquidity might in fact reduce savings rates because of the ambiguous effects of uncertainty on savings, since less uncertainty may decrease the demand for precautionary savings.
Thirdly, highly liquid stock markets affect corporate governance negatively because they encourage investor myopia. This discouragement on investors in having long term commitment with firms whose shares they hold, portend serious adverse consequences on economic growth.
Theoretically, as mentioned earlier, there is disagreement among economists on the role of stock markets in economic growth. The demand following growth led theorists maintain that economic growth creates a demand for various types of financial services to which the financial system responds.
Stock Market Development and Economic Growth in Nigeria: Market Size Versus Liquidity | Ovat | Canadian Social Science
Moreover, some skeptical economists express skepticism in the finance - growth relationship and argue that the relationship that has been over - stressed is actually not important Lucas , The emergence of the new endogenous growth model has also given a new impetus to the finance - growth nexus. Indeed, financial markets can have a strong impact on real economic activity. As argued by Hermes , financial liberalization theory and the new growth theories basically assume that financial development leads to economic growth.
From the literature explored above, it is obvious that the debate is far from being settled. This study therefore represents an attempt to re-examine the finance - growth relationship from the perspective of the stock market in Nigeria. The study utilizes the Granger Causality framework in analyzing the causal relationship between stock market development and economic growth.
Before carrying out this analysis, several econometric tests are conducted. First, is the unit root test which seeks to determine the stationarity status of the variables used in the models. In this test, the study employs the Augmented Dickey Fuller test ADF.
Second, Johansen Maximum Likelihood co-integration test is conducted to ascertain whether or not there exists a long-run relationship among the variables under investigation.
The study employs quarterly high frequency time series data, sourced mainly from the Central Bank of Nigeria CBN Statistical Bulletin various issues for the period, to The choice of high frequency data is informed by the fact that stock market activities are performed on daily basis. Stock market development is measured by three indicators, namely, market capitalization ratio MCR , turn over ratio TRO and total value of shares traded ratio STR. Market Capitalization Ratio MCR: This measure equals the value of listed shares divided by GDP.
It is assumed that overall market size is positively correlated with the ability of the market to mobilize capital and diversify risk on an economy - wide basis. This is quantified by the value of total shares traded divided by market capitalization.
The turn over ratio is seen as a complement of market capitalization ratio. A large but inactive market will have a large market capitalization ratio but a small turn over ratio.
Indeed turn over ratio measures trading relative to the size of the stock market. A small but liquid market will have a high turnover ratio while a large but illiquid market will have a low turn over ratio. Total Value of Shares Traded Ratio STR: This measure is quantified by the total value of shares traded in the stock exchange market divided by GDP. In fact the ratio of value of shares traded relative to GDP is an indictor of the activity and liquidity of the stock market.
A part from the above three indicators of stock market development, the study controls for financial deepening, quantified as the ratio of broad money supply M 2 to nominal GDP. From the literature, financial deepening exerts some influence on economic growth. The use of control variables in regression analysis is to avoid the problem of simultaneity bias Choong et al.
To probe into the issue of causality in the relationship between stock market development and economic growth, the study adopts the Granger causality test. The test relies on estimating two basic equations as follows:. Where X denotes an indicator of stock market development, Y denotes economic growth and the subscripts t and t-i, t-j denote the current and lagged values.
Empirical results and analysis. To avoid producing spurious regression results, the study first carr ies out unit root test using the Augmented Dickey-Fuller ADF test. The results suggest that apart from MCR that is stationary at level, other variables are stationary at their first differences. Unit root results are presented in Table 1. Next, cointegration test is performed. The results are presented in Table 2.
From the results, the trace statistic indicates 3 cointegrating equations at the 5 percent level. Also, the maximum Eigen value test indicates 1 cointegrating Vector at both the 5 percent and 1 percent levels. This suggests the existence of a long run relationship among the variables under study, and they are coi ntegrated. Johansen Cointegration Test Results. Pairwise Granger Causality Test Results.
Furthermore, having verified the existence of a long run relationship among the variables, the direction of causality is examined between the various indicators of stock market development and economic growth. The results of the g ranger causality test are summarized in table 3.
The results indicate that there is a bidirectional causality between value of shares traded ratio STR and economic growth LY , turnover ratio TRO and economic growth L y and a unidirectional causality between financial deepening M 2 Y and economic growth while no causal relationship exists between market capitalization ratio MCR , proxy for the size of the stock market and real GDP LY proxy for economic growth. The implication of the results is that stock market dev elopment contributes significantly to economic growth in Nigeria through the market liquidity based indicators total value of shares traded ratio and turn over ratio creating a feed back effect as growth in economic activity also stimulates the liquidity in the stock market.
However, the strength of causality is greater in stock market liquidity in this bidirectional relationship. From the empirical results, an improvement in trading of shares, as in number of shares traded, frequency in trading on the Nigerian stock market will boost economic growth by 4.
From the perspective of the turnover ratio TRO which is another indirect indicator of liquidity, any policy measure that tends to increase the turn over ratio in the Nigerian Stock Market will lead to economic growth by 2. The empirical analysis however, viewed from the perspective of stock market size, captured by market capitalization relative to GDP implies that the stock market size in Nigeria does not have a significant effect on economic growth.
The coefficients of the calculated F-statistic for both variables MCR and LY are not statistically significant suggesting that; no causal relationship exists between the two variables T able 3. The study investigates into the acclaimed catalytic impact of developed stock markets on economic growth with evidence from the Nigerian stock market.
It disaggregates stock market development into stock market size and stock market liquidity with a view to providing evidence on the aspect of stock market development that is the main driver of growth in Nigeria. Utilizing several econometric techniques such as unit root test, cointegration and Granger causality test, the study produces interesting and far reaching results that tend to suggest a bidirectional causal relationship between market liquidity based indicators of stock market development and long run economic growth while stock market size contributes insignificantly to economic growth.
Equally, the findings also shed light on the positive impact of financial deepening on growth in Nigeria. Thus the empirical findings while suggesting the dominance of market liquidity over market size in the growth process also show that the value of shares traded ratio is a better measure of liquidity in the Nigerian context. These findings are consistent with Filer et al. In view of the appreciable growth the Nigerian stock market has undergone over the years, which prompted its listing by the international Finance Corporation as one of the emerging markets in the world, and its resultant positive impact on economic growth in Nigeria, as shown by the foregoing empirical analysis, the study concludes with the following policy recommendations that could sustain and further drive this growth process.
First, the use of electronic trading systems should be intensified and the encouragement of new listings. These could go a long way to further boost the liquidity on the Nigerian stock market and further accelerate growth in Nigeria.
Second, there should be drastic reduction in transaction costs. Low transaction costs are often seen as indicative of high turn over ratio which in turn is an indication of increase in liquidity and a high liquidity boosts economic growth. Finally, policies should be directed towards increasing the size of the market by way of increasing the number of listed companies, reduction in the cost of public quotation, and making the requirement for listing less stringent.
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About The Author Okey O. Home About Login Register Categories Search Current Archives Announcements Index Publisher Recruitment Journals A-Z. Received 12 August ; accepted 15 October Abstract This study investigates empirically into the acclaimed positive role played by stock markets in driving growth, with evidence from the Nigerian stock market.
Stock market size ; L iquidity ; E conomic growth ; C ausality ; Nigeria Okey O. Empirical literature and theoretical issues Empirical investigations of the link between stock market development and economic growth have been relatively limited in developing countries, especially Nigeria.
The test relies on estimating two basic equations as follows: Empirical results and analysis To avoid producing spurious regression results, the study first carr ies out unit root test using the Augmented Dickey-Fuller ADF test.
Table 1 Adf Unit Root Test Results Varlables Unit Root Coefficient Decision D LY D M2Y MCR D STR D TRO Table 2 Johansen Cointegration Test Results. LY M2Y MCR STR TRO Hypothesized No. Table 3 Pairwise Granger Causality Test Results Null hypothesis Obs. Summary and conclusion The study investigates into the acclaimed catalytic impact of developed stock markets on economic growth with evidence from the Nigerian stock market.
Journal of Economic Literature , 35 , Levine, R. Search Scope All Authors Title Abstract Index terms Full Text. MCR does not Granger cause LY LY does not Granger cause MCR. STR does not Granger cause LY LY does not Granger STR. TRO does not Granger cause LY LY does not Granger cause TRO. M2Y does not Granger cause LY LY does not Granger cause M2Y.