Stock market development and economic growth in developing countries: Evidence from Saudi Arabia

Abstract

This study investigates the long-term and short-term relationships between stock market development and economic growth in the Kingdom of Saudi Arabia (KSA) for the period from January 1993 to December 2009. It employs a wide range of vector autoregression (VAR) models to evaluate the importance and impact of stock market development on economic growth. We used real GDP growth rates as a proxy for economic growth and the stock market index (SMI) as a proxy for the stock market development. The vector-error cointegration model (VECM) indicates a significant long-term causal relationship between economic growth and the stock market development. Granger causality tests show weak bidirectional causal relationship between stock market development and economic growth supporting the feedback view in the short run. The study implications are as follows. Firstly, investment in real economic activities leads to economic growth. Secondly, the stock market might hinder economic growth due to its volatile and international risk sharing nature, low free-floating share ratio, number of listed companies and the domination of Saudi Individual Stock Trades (SIST) characteristics. Thirdly, policymakers should seek to minimise stock market volatility and fluctuations, increase both the free-floating share ratio and number of listed companies and shift investment domination toward corporate investors by considering its effect on economic growth when formulating economic policies.