Stock market and the economic growth predicts future

Introduction

The argument of whether stock market is associated with economic growing or the stock market can be served as the economic index to foretell hereafter. The purpose of the survey is to happen the relation between the stock market public presentation and the existent economic activity in instance of four states The UK, The USA, Malaysia and Japan. With my limited cognition I have tried to happen out the function of fiscal development in exciting economic growing. A batch of economic experts have different position about stock market development and the economic growing.

However, there are grounds of controversial issue about the ability of anticipation from the stock market is non dependable if there is a state of affairs like 1987 stock market crashed followed by the economic recession and 1997 fiscal crises.

The argument of whether stock market is associated with economic growing or the stock market can be served as the economic index to foretell hereafter. The purpose of the survey is to happen the relation between the stock market public presentation and the existent economic activity in instance of four states The UK, The USA, Malaysia and Japan. With my limited cognition I have tried to happen out the function of fiscal development in exciting economic growing. A batch of economic experts have different position about stock market development and the economic growing.

If we focus on some related literature published on this subject one inquiry arises:

Is economic development is affected by stock market development?

Even though there are tonss of argument on some are stating that stock market can assist the economic system but the consequence of stock market particularly in the economic system is really small. Ross Levine suggested in his paper published in 1998 that recent grounds suggested stock market can truly give a roar to economic growing. Levine, R ( 1998 )

It is non truly possible to mensurate the growing by merely looking at the ups and down in the stock market index and by looking at the rates of growing in GDP. Harmonizing to many economic experts stock market can be a ground for the future downswing if there is a immense lessening in the stock monetary value or frailty versa.

A batch of things can do growing of stock market like alterations in the banking system, foreign engagement in the in the fiscal market may take part strongly. Apparently it seems that these developments can do development of stock market followed by the good economic growing. But to look into the truth one required to follow an appropriate method which would meaningfully mensurate whether stock monetary value is truly set uping the economic growing or non?

In our work we have tried to happen out the carbon monoxide integration and causal relationship between Stock monetary value and GDP and tried to look into if there is a long tally and short tally relationship between the stock monetary value and GDP.

The method used for the surveies is Engle Granger carbon monoxide integrating method. To make this we have used ADF ( Augmented Dickey Fuller Test ) to look into for the stationary behavior of the variables and so we have performed the Engle Granger Engle Granger carbon monoxide integrating method followed by residuary based mistake rectification theoretical account. To look into for the short tally relationship we have used 2nd phase Engle Granger carbon monoxide integrating method.

To look into the causal consequence of the four states stock market and economic growing we used Granger Causality Method. In this paper I have reviewed some surveies of bookmans which I have discussed on the literature reappraisal portion. This paper contains five parts

Part two is about the literature based on the past wok of bookmans. Part Three discussed about the Data and methodological analysis. Consequences are discussed on portion four and portion five is all about the drumhead and decision of the whole survey.

In our work we have founded there is no long tally relationship between stock market and economic growing in USA and UK and being of long tally relationship in Japan and Malaysia. In add-on there is no causal relation between stock index output and the national economic system growing rate. The empirical consequences of the thesis concludes that the possibility of apparently unnatural relationship between the stock index and national economic system of these for states.

Literature Reappraisal:

Mun, H. et Al. ( 2008 ) stated in their survey Stock market contributes to economic growing in different ways either straight or indirectly. Savings mobilisation, Liquidity creative activity, and Risk variegation, maintain control on disintermediation, information gaining and enhanced inducement for corporate control are considered as the chief map of stock market.

The relationship between stock market and economic growing has become an issue of extended analysis. There is ever a inquiry whether the stock market straight influence economic growing. A batch of research and consequences shows that there is a strong relationship between stock market and economic growing. Evidence on whether fiscal development causes growing is assisting us to convey together these positions. If we go through the literature, a considerable sum of literature suggests that the dealingss are positive between stock market and economic growing.

Reverting back to the survey of Schumpeter ( 1912 ) , his surveies emphasizes that influences are positive on the development of a state ‘s economic sector on the degree and the possible hazard of losingss caused by the inauspicious choice and moral jeopardy or dealing costs. And the necessary the rate of growing that helps fiscal sectors provides of reapportioning capital to minimise the possible losingss.

Empirical grounds from king and Levine ( 1993 ) show that the degree of fiscal intermediation is a good forecaster of long tally rates of growing, capital accretion and productiveness. Enhanced liquidness of fiscal market leads to fiscal development and investors can easy diversify their hazard by making their portfolio in different investings with higher investing.

Levine. R ( 1991 ) said that if equity can be traded easy in a stock market the growing is more pronounce on those sort of economic system. Another survey from Levine and Zervos ( 1996 ) utilizing the information of 24 states found that a strong positive correlativity between stock market development and economic growing. Their expanded survey on 49 states from 1976-1993, they used Stock Market liquidness, Economic growing rate, Capital Accumulating rate and end product Growth Rate. They found that all the variables are positively correlated with each other.

The survey of Ross Levine and Zervos, ( 1998 ) , to happen out the long tally relationship between stock market and bank suggest a positive consequence both the variables has positive consequence on economic growing. International integrating and volatility is non decently effected by capital stock market. And private save salvaging rates are non at all affected by these fiscal indexs. The survey was done on 47 states informations utilizing transverse sectional analysis. In theory the conventional literature on growing was non truly sufficient plenty to look for the connexion between fiscal development and economic growing and the ground is they were focused on the steady province degree of capital stock per worker of productiveness. And they were non truly concentrated on the rate of growing. Actually the chief concern was legitimated to exogenic proficient advancement.

Arestis and Demetraides ( 1997 ) stated about two carbon monoxides incorporating relationship between fiscal development and economic growing, utilizing Johansen co-integration method on the macro informations of two developed state ( US and Germany ) . The variables they have used were banking system development, stock market volatility and Real GDP.

Positive correlativity was found in Germany between banking system development and existent GDP per capita, nevertheless negative relationship was found between stock market volatility and GDP. Positive relationship was found in their survey between banking system development and stock market capitalisation. US instance is more hard because of the endogenous behavior of stock market capitalisation. They suggested that stock market might hold some consequence on economic growing.

Demiurgic and Maksimovic ( 1996 ) have found positive causal effects of fiscal development on economic growing in line with the ‘supply taking ‘ hypothesis. Harmonizing to his surveies states with better fiscal system has a smooth working stock market be given to turn much faster. The ground can be they have entree to much needed financess for financially forced economic endeavors by the big efficient Bankss.

Chung S. Kwon and Tai S. Shin ( 1999 ) studied the relationship between the stock market index, end product index, trade balance and money supply and economic growing by utilizing co-integration and Granger causality method. They founded from the co-integration trial vector mistake rectification theoretical account that stock monetary value indices are integrated with a set of macroeconomic variables which are the production index, exchange rate, trade balance and money supply, and there is direct long tally equilibrium relationship with each stock monetary value index. They stated that stock monetary values are signalling in alterations but it is non the taking variable of economic fluctuation.

Related research was done for the past three decennaries concentrating on the function of fiscal development in exciting economic growing they ne’er considered about the stock market.

An article by Chakraborti, I. ( 2006 ) , based on the instance of India presented in a seminar in Kolkata in October, 2006 provides some information about the being of long tally stable relationship between stock market capitalisation, bank recognition and growing rate of existent GDP. She used the construct of the farmer causality after utilizing both the Engle-Granger and Johansen co integrating technique. In her survey she found GDP is co-integrated with fiscal deepness, Volatility in the stock market and GDP growing is co integrated with all the findings the paper explain that the in an overall sense, economic growing is the ground for fiscal development in India.

Odit. M, ( 2009 ) studied with clip series informations over the period 1989-2007 to happen the short tally and long tally relationship by building an ECM and the consequence shows that stock market development has a positive impact on economic growing in Mauritius both in long tally and short tally.

Few authors from Malaysia found that stock market does assist to foretell future economic system. Stock market is associated with economic growing drama as a beginning for new private capital. Causal relationship between the stock market and economic growing which was done by utilizing the formal trial for causality by C.J. Granger and annually Malaysia informations for the period 1977-2006. The consequence from the survey explains that future anticipation is possible by stock market.

A survey focused on the relationship between stock market public presentation and existent economic activity in Turkey. The survey shows being of a long tally relationship between existent economic activity and stock monetary values… … … … … … … … … … … … … … Consequence from the survey pointed out that economic activity additions after a daze in stock monetary values and so diminutions in Turkish market from the 2nd one-fourth and a unitary ( Turkish paper )

An international clip series analysis by Rajan R. G and Zingales, cubic decimeter ( 1998 ) from 1980-1990 found some grounds of the relation between stock market and economic growing. This paper describes whether economic growing is facilitated by fiscal development. He found that fiscal development has strong consequence on economic growing.

Nieuwerburg, S et Al ( 2005 ) , Belgium Stock market survey with economic development shows the positive long tally relationship between both the variables. In instance of Belgium the groundss are quiet strong that Economic growing is caused by the development of the stock market. It is more focussed between the period 1873 and 1935 ; fundamentally this period is considered as the period of rapid industrialisation in Belgium. The importance of the stock market in Belgium is more marked after liberalisation of the stock market in 1867-1873. The clip changing nature of the nexus between stock market development and economic growing is explained by the institutional alteration in the stock exchange. They besides tried to happen out the relationship to the universal banking system. Before 1873 the economic growing was based on the banking system and after 1873 stock market took the topographic point.

Senior economic expert of the World Bank ‘s Policy research section Ross Levine has discussed about Stock market in his paper Stock Markets: A Spur to economic growing on the impact of development. Less hazardous investings are possible in liquid equity market and it attracts the rescuers to get an plus, equity. As, they can sell it rapidly when they need entree to their economy, If they want to change their portfolio. Though many long term investing is required for the profitable investing. But reluctance of the investors towards long term investing as they do n’t hold the entree to their nest eggs easy. Permanent entree to capital is raised by the companies through equity issues as they are easing longer term, more profitable investings and chance of long term economic growing is enhanced as liquid market improves the allotment of capital. The empirical grounds from the survey strongly suggests that greater stock markets create more liquidness or at least continue economic growing. ( Levine. R A goad to economic Growth )

Bencivenga and Smith ( 1992 ) , another of import characteristic of stock market, it reduces seizing the liquid assets and increases the growing rate of physical capital to heighten economic growing at least in the long tally. It can be negative in the short tally because a stock exchange additions ‘households ‘ wealth coincident ingestion besides rises which lowers the economic growing specially in freshly formed stock exchanges.

A batch of research has established that future economic growing is influenced by state ‘s fiscal growing, stock market index returns are another factor of economic growing. The research worker focused to widen their survey ; they tie together these two strings and started analysing the relationship between banking industry, stock returns and future economic growing. Research was done on 18 developed and 18 emerging markets and the consequences are positive and singular relationship between future GDP and stock returns. Few of import characteristics can besides be predicted such as bank-accounting-disclosure criterions, banking crises, insider trading jurisprudence enforcement and authorities ownership of Bankss.

( Bank stock returns and economic growing Q Rebel A. Cole a, Fariborz Moshirian B, * , Qiongbing Wu c a Department of Finance, DePaul University, Chicago, IL 60604, USA b School of Banking and Finance, The University of New South Wales, Sydney, NSW 2052, Australia c Newcastle raduate School of Business, The University of Newcastle, Newcastle, NSW 2300, Australia Received 29 September 2006 ; accepted 26 July 2007Available online 21 September 2007 )

Another paper was focused on the linkages between fiscal development and economic growing utilizing TYDL theoretical account for the empirical exercisings by Padhan, P ( 2007 ) suggests that both stock monetary value and economic activity are integrated of order one and Johansen-Juselias Coin-integration trials for this survey found one carbon monoxide incorporating vector exists. It is proved by the specious relation regulation in this survey the being of at least one way of causality. He described that bi-directional causality between stock monetary value and economic growing significance that economic activity can be enhanced by good developed stock exchange and vice-versa.

Choong, C et Al ( Jul,2003 ) tried to happen out the importance of the causal relationship of fiscal development and economic growing. The findings of their survey utilizing autoregressive Distributed slowdown ( ARDL ) describes about the positive long tally impact on economic growing Granger causality besides suggest same consequences.

Filler R. et Al ( 1999 ) , found important causal relationship between the stock market development and economic growing in less developed states. Granger causality method was used to happen out the relationship p. The findings of their consequences are future economic growing can be predicted in low and lower in-between income states but non in the higher income states with more developed alternate fiscal mechanism. They mentioned about the inordinate corruptness or authorities intervention in fiscal market hamper the economic growing in less developed states as increased equity market has no impact on growing because of deficiency of proper institutional model. Active equity market is an active engine of growing in economic system in developing economic systems if the institutional model is free from corruptness.

A survey by Filler, R ( 2000 ) utilizing 70 states informations over the period 1985-1997 proves that there is a really small relationship between economic growing and stock market particularly in developing states and currency grasp has occurred. From the consequence of the survey we can see that an of import function may be played by the stock market in an economic system, and these are non indispensable for economic growing.

A successful part of stock market is planetary hazard variegation chances. Whereas contradictory statement by Obstefeld ( 1994 ) . They argued there is a opportunity for high hazard and high return both in domestic and international executable undertaking. Savingss and investing chances are more expeditiously allocated. In a well developed stock market publically available information gives thought about the investing chances. The rate of growing in economic system is higher because better investing determination are than taken by the investors and the can apportion their portfolio in profitable investings.

Poon, S and Taylor, J ( 1992 ) , stated about no important relationship between UK stock market and economic growing. Their survey was based on the information all portion index from January 1965 to December 1989 utilizing ARCH theoretical account. The relationship was unexpected between the return constituents and volatility series and was non statistically important.

However, another survey on Iran by Shahnoushi, N, et Al ( 2008 ) , fiscal development is non considered as an effectual factor to the economic growing. The survey was focused on the causal relationship between the fiscal development and economic growing. Time series informations used for the survey from the period 1961-2004. Granger causality shows there is no carbon monoxide incorporating relationship between fiscal development and economic growing in Iran merely the economical growing leads to fiscal development.

An empirical survey by Men M and RUI ( 2006 ) on Stock market index and economic growing in China suggest that possible ground of evident unnatural relationship between the stock Index and national economic system in China. Apparent unnatural relationship may be because of the undermentioned ground incompatibility of Chinese GDP with the construction of its stock market, function played by private sector in growing of GDP and disequilibrium of finance construction etc. The survey was done utilizing the co-integration method and Granger causality trial, the overall determination of the survey is Chinese finance market is non playing an of import function in economic development.

Establishing nexus between nest eggs and investing is really much of import and fiscal market provides that. Transient or permanent growing is the ultimate affect of the fiscal market. Economic growing can be influenced by fiscal market by bettering the productiveness of the capital, Investment to houses can be channelled and greater capital accretion by increasing nest eggs. To guarantee the stableness of the fiscal market potency ordinance is of import due to asymmetric information, particularly at the clip of fiscal liberalisation.

3. Datas:

The empirical analysis was carried out utilizing the quarterly information for The UK, The USA, Japan and Malaysia. The informations were collected from the DataStream for the period 1993I to 2008III. Economic growing is measured as the growing rate of gross domestic merchandise ( GDP ) of each state with the aid of stock monetary values SP. For the package processing we use Eviews 6.0 for the planned arrested development in order to acquire the consequences. The empirical analysis is done from the quarterly informations from the stock market indices and the GDP between the first one-fourth of 1993 and the 4th one-fourth of 2008. All the information has been extracted from the informations watercourse and expressed in US $ . The information for Japan portion monetary value is from Tokyo Stock Exchange. Malaysia ‘s Share monetary value is form Kuala Lumpur Composite Index, UK ‘s is from UK FT all portion monetary value index and USA portion monetary value is taken from the DOW Jones industrial portion monetary value index.

The nature of the Data is series used for the clip series arrested development.

3.1 Variable Description:

Methodology:

Co-integration long term common stochastic tendency between non stationary clip series. If non-stationary series x and yare both integrated of same order and there is a additive combination of them that is stationary, they are called carbon monoxide integrated series. A common stochastic tendency is shared in Co-integration. It follows that these two series will non float apart excessively much, intending that even they may divert from each other in the short-run, they will return to the long-term equilibrium. This fact makes co-integration a really powerful attack for the long-run analyses.

Meanwhile, co-integration does non connote high correlativity ; two series can be co incorporate and yet hold really low correlativities. Co-integration trials allow us to find whether fiscal variables of different national markets move together over the long tally, while supplying for the possibility of short-term divergency. The first measure in the analysis is to prove each index series for the presence of unit roots, which shows whether the series are nonstationary. All the series must be nonstationarity and integrated of the same order. To make this, we apply both the Augmented Dickey-Fuller ( ADF ) trial. Once the stationarity demands are met, we proceed Granger bivariate co-integration ( 1987 ) process. 30 International Research Journal of Finance and Economics – Issue 24 ( 2009 )

4.1 Series Stationary Test:

In this survey I have used Augmented Dickey Fuller Test ( ADF ) to prove the stationary of variables. The unit root trial is normally used to corroborate stationary of a series. The ADF is trial for unit root where I have checked the Unit root and strong negative Numberss of unit root is being rejected by the void hypothesis ( degree of significance ) . ADF trial is based on the estimation of the undermentioned arrested development:

Here with the trial we can happen the estimations of vitamin D are equal to zero or non. Y is said to be stationary if the cumulative distribution of the ADF statistics by demoing that if the deliberate ratio of the coefficient is less than the critical value harmonizing to Fuller ( 1976 ) . If we accept the Ho the sequence is predicted to be holding unit root and if Ho is rejected so we can state that the series does n’t hold unit root. This proves that the series is stationary. The co-integration trial can merely be performed if both the sequences are all integrated of order I ( 1 ) .

4.2 Co-integration Trial:

Engle and Granger ( 1987 ) foremost established the co-integration method. It is a method of mensurating long term variegation based on informations. Linear combination of two non stationary series shows that they are integrated in order one I ( 1 ) that is stationary. And this is a carbon monoxide incorporate series.

Co-integration is a Long term common random tendency between non stationary clip series. The additive combination of both the non stationary series can be stationary if both the variables are integrated in same order. Co-integration is a really powerful attack in the long term analysis because a common stochastic tendency is shared in co-integration that average two series will non float individually excessively much. They might divert from each other but in the long tally but finally the will return back in the long tally.

If there is really low correlativity between the series still the series can be co-integrated as high correlativity is non implied in co-integration. The ground for taking the method as it will let us to look into the move between the variable in the long tally even there might be a divergency in the short tally.

The first measure in the analysis is look into each index series whether the series for the presence of unit root which shows whether the series is non stationary. The method that I followed to make this is Augmented Dickey Fuller Test ( ADF ) . I proceed the Granger co-integration technique 1987 when the stationary demands are met.

Harmonizing to Engle and Granger ( 1987 ) to look into for co-integration if both the variables yt and crosstalks are integrated with order one the proposed method for co-integration residual-based trial for co-integration ( Engle-Granger method ) .

And after that a and & A ; szlig ; is denoted as the estimated arrested development coefficient vectors. After that I saved the remainder from the above equation.

Then, e = yt – a – & A ; szlig ; xt is stand foring the estimated residuary vector. If the residuary vitamin E is integrated with order nothing that means the series for the residuary is stationary, and xt and yt are so co integrated and frailty versa. I have checked it by executing Augmented Dickey Fuller trial on the residuary series on flat value with intercept and with intercept and tendency for each state.

An in this state of affairs ( 1, – & A ; szlig ; ) is called co-integrating vector if the series is stationary.

Therefore yt=a+ & A ; szlig ; xt +et is a carbon monoxide incorporating equation, so, from it we can state that there is long tally relationship between xt andyt.

Granger representation theorem suggests that if there exists a long tally relationship there exist an mistake rectification mechanism which can be placed in the short tally equations.

4.3 Granger causality trial:

Granger causality trial is applied if the relationship is lagged between the two variables to find the way of relation in statistical term. It gives information about the short term relationship between the variables.

In footings of conceptual definition causality is consist of different thoughts, this construct produce a relation between caused and consequences were agreed upon. Aristo defines that there exist a nexus between causes and consequences and without causes these consequences are impossible. And this is strong relationship.

Some economic experts believe that the thought of causality is the mix of both theoretical and account and statistical construct. The frontline operational definition of causality is given by some economic expert, but Granger is the 1 who provided the information to understand it right and wholly.

Granger causality attack ( 1969 ) , let ‘s believe the variable Y is Economic Growth ( GDP ) and x is Stock monetary value index, if it is possible to foretell the past values of Y and ten than from the lagged values of Y entirely. Ten is said to be granger caused by and Y is assisting in foretelling it. In instance of a simple bivariate theoretical account, causality can be tested between stock market growing and economic growing. Granger causality tally on the footing of the undermentioned bivariate arrested developments of the signifier:

Where GDP denotes economic growing and SP denotes the stock monetary value index and they explain the alterations in growing. Variables are expressed in logarithm signifier. The distribution of u1t and u2t are uncorrelated by premise.

From the equation one it can be said that current GDP is related to lagged values of itself and every bit good as that of SP. And equation 2 posits same sort of behavior for SP.

Both the equations can be obtained by ordinary least squares ( OLS ) . The f statistics are the Wald statistics for the joint hypothesis: & A ; szlig ; j=0 ( j=1,2,3… ..q ) and F trial is carried out for the void hypothesis of no Granger causality.

The expression of f statistic is agged term is defined here by m ; figure of parametric quantity is defined as K.