Financial development and economic growth: an empirical investigation of the role of banks and institutional investors

Abstract

This article gives a new light on the finance-growth nexus through the investigation of the role of institutional investors as providers of risk diversification in the process of economic growth. We make use of panel cointegration techniques to study the potential long-run relationship between economic growth, banking development and institutional investors in six Organization for Economic Co-operation and Development (OECD) countries. Our results highlight some heterogeneity in the long-run relationship between financial development and growth. Institutional investors are shown to support long-run economic growth in only two countries. We also report a negative long-run relationship between both indicators of financial development.

Keywords:

• economic growth
• banks
• institutional investors
• panel cointegration
• causality

JEL Classification::

• E44
• G20
• O16

Notes

¹ The effect of risk mitigation provided by financial institutions on the saving rate is nevertheless ambiguous and depends on the relative intensity of income and substitution effects (see Devereux and Smith, 1994; Levine, 1997).

² Data availability on institutional investors and the length required from time series to achieve convergence in our panel cointegration methodology constrained our choice to those six OECD countries.

³ Cross-unit cointegration is however not possible under this methodology.

⁴ That is the coefficient in related to x in Equation 5 with y as the dependent variable. This test is distributed.

⁵ Note that the analysis focuses on country-by-country results but still within the system of Equation 5. Thus, the results account for the presence of cross-unit contemporaneous dependence.