Stock Market Development and Economic Growth

Problem statement: This study investigated the causal relationship between stock market development and economic growth for France for the period 1965-2007 using a Vector Error Correction Model (VECM). Questions were raised whether stock market development causes economic growth or reversely taking into account the negative effect of interest rate. Stock market development is estimated by the general stock market index. The objective of this study was to examine the causal relationships between these variables using Granger causality tests based on a Vector Error Correction Model (VECM). Approach: To achieve this objective unit root tests were carried out for all time series data in their levels and their first differences. Johansen co-integration analysis was applied to examine whether the variables are co-integrated of the same order taking into account the maximum eigenvalues and trace statistics tests. A vector error correction model was selected to investigate the long-run relationship between stock market development and economic growth. Finally, Granger causality test was applied in order to find the direction of causality between the examined variables of the estimated model. Results: A short-run increase economic growth of per 1% leaded to an increase of stock market index per 0.24% in France, while an increase of interest rate per 1% leaded to a decrease of stock market index per 0.64% in France. The estimated coefficient of error correction term found statistically significant with a negative sign, which confirmed that there was not any problem in the long-run equilibrium between the examined variables. The results of Granger causality tests indicated that economic growth causes stock market development in France. Conclusion: Therefore, it can be inferred that economic growth has a positive effect on stock market development, while interest rate has a negative effect on stock market development in France."