Interrelationships among banks, stock markets and economic growth: an empirical investigation

Abstract

This article utilizes a simultaneous equations model to study the relationships among economic growth, banking and stock market development. In contrast to conventional instrumental variable approach, we implement the analysis via the methodology of identification through heteroscedasticity. Using Beck and Levine (2004) dataset, we find that each of the three variables interacts in important ways. While both are conducive to economic growth, banking development matters more for growth in low-income countries and stock market development is more favourable to growth in high-income or low-inflation ones. The data also reveal coexistence of a positive effect of banking development on stock market development and a negative effect of stock market development on banking development. Besides, the feedback effects of growth on both banking and stock market development are found.

Keywords:

• economic growth
• financial development
• identification through heteroscedasticity

JEL Classification:

• C33
• G21
• O16

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Erratum

Acknowledgements

The authors are grateful to R. Rigobon and T. Beck, respectively, for making available computer code and the data used in this article. The authors report no conflicts of interest. The authors alone are responsible for the content and writing of the article.

Notes

1. Please see Levine (2005) for a detailed survey.

2.  However, Calderon and Liu (2003) and Huang and Lin (2009) find the opposite to be true. Financial deepening contributes more to the relationship in developing countries than in industrial ones. Rousseau and Wachtel (2011) show that countries with moderately developed financial sectors or countries with middle levels of per-capita income have a stronger and significant impact of financial deepening on economic growth.

3. Please see Ang (2008) for a broader discussion of empirical limitations related to time-series and cross-country analyses.

4. For instance, empirical studies of Levine and Zervos (1998), Arestis et al. (2001), Rousseau and Wachtel (2000) and Beck and Levine (2004) investigate whether banks and stock markets play a distinct role in the growth process and find that bank and stock market development individually and jointly promote economic growth.

5.  Without loss of generality, we omit subscripts for notational simplicity.