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1 Business and Economics Journal, Volume 2010: BEJ-1
St ock M arket and Economic Gr ow t h: An Empirical Analysis f or Ger many
Adamopoulos Ant onios
Depar t ment o f Appl ied Info rmat i cs, Uni ver si t y o f M acedoni a, Th essaloni ki , M acedon ia, Gr eece
Cor r esp ondence t o: Adamopoul os Ant oni os, adamant @uo m.gr
Publ i shed onl i ne: Apr il 15, 2010
Abst r act
Th i s paper i nvest i gat es t he causal relat i onship bet w een st ock market devel opment and economic gr owt h f or Ger many f or t h e peri od
1965-2007 using a Vect or Er ro r Co rr ect io n M odel (VECM ). The pur pose of t h is paper w as t o examin e t h e long-run r el at i on sh i p
bet ween t hese var iabl es, app lyi ng t he Johansen co-in t egr at i on analysis based on t he cl assi cal uni t r oo t s t est s. The r esul t s of Gr anger
causal i t y t est s i nd icat ed t hat t here i s a uni di rect i onal causal it y bet ween st ock mar ket d evel opment and econo mi c gr owt h wi t h
di r ect i o n f rom st o ck mar ket d evel opment t o economi c gro wt h .
Keyw ords: St ock market ; Economi c gr ow t h ; VAR model ; Granger causal it y.
1. Int roduct ion
St ock mar ket development has b een t he sub j ect o f i nt en si ve t heor et ical and empi r i cal st udi es [ 1, 2] . M o r e r ecen t l y, t h e
emp hasi s has i ncr easi ngl y shi f t ed t o st ock mar ket i ndexes and t he ef f ect of st ock mar ket s on economi c developmen t .
St ock mar ket cont r ibut es t o t h e mob il i zat i on o f domest i c savings b y enhan cing t he set of f inan cial in st r umen t s avail abl e
t o saver s t o di ver sif y t hei r p or t f ol i os p rovi ding an i mpor t ant sour ce o f i nvest men t capi t al at r el at ivel y l ow cost . A w ell
f unct i oning and l iqui d st ock mar ket , t h at all ow s i nvest or s t o di ver sif y aw ay unsyst emat i c r i sk, w i l l i ncr ease t he margi nal
pr oduct i vi t y of cap it al [ 3] .
Anot her i mpo r t an t aspect t hr ough whi ch st ock market developmen t may in f luence economic gr ow t h i s r i sk
di ver si f i cat ion. Ob st f el d [ 4] suggest s t hat i nt er nat i onal r i sk shar ing t hr ough in t er nat ional l y i nt egr at ed st ock mar ket s
i mpr oves t he all ocat i on of r esour ces and accel er at es t h e pr ocess of economic gr ow t h .
Evol ut i on of st ock mar ket has impact on t he operat i on o f banki n g in st i t ut i ons and h en ce, on economic pr omo t i on . Th i s
means t hat st ock mar ket i s b ecomi ng mo re cru cial , esp eciall y i n a number of emer gin g mar ket s and t heir rol e should not
be i gnor ed [ 5] . Levi ne and Zer vos [ 2] argued t hat a w el l -est ab li shed st o ck mar ket n ot on l y can mobi l ize capi t al and
di ver si f y r i sks bet w een mar ket agent s but al so it is abl e t o p rovi de di f f er ent t yp es of f i nancial ser vi ces t han banking
sect or t o st i mu lat e economi c gro w t h .
Th e necessit y of st ock mar ket devel opmen t i s an i mper at i ve need in o r der t o achi eve fu l l ef f ici ency of cap it al al l ocat ion
i f go vernment can l i berali ze t h e f i nancial syst em. As f ar as physical accumul at i on i s concern ed , bo t h st ock market s an d
banks pro vi de sour ces of ext ernal f i nan cing f or f ir ms. For t he pu rpose o f r esour ce al l ocat i on, t hey bot h cr eat e
i nf or mat ion t o gui de t he al lo cat i on o f r esour ces. They di f f er onl y i n t he way t he in fo rmat i on is t r ansmi t t ed . Inf or mat ion
i n st ock mar ket s i s con t ained in equi t y p r i ces, w hi l e l oan manager s col lect t hat i n banks. Ther efo r e, whi l e banks f inance
on ly w el l-est abl i shed, saf e bor row er s, st ock mar ket s can f i nance r i sky, pr oduct i ve and innovat i ve i nvest ment pr oj ect s
[ 6] .
Fama and Sch wer t [ 7, 8] cl ai m t hat t her e ar e t h r ee exp lanat i on s fo r t h e st r ong l in k bet w een st ock pr ices and r eal
econ omi c act i vi t y: Fi r st , i nf or mat i on ab out fu t ur e r eal act i vi t y may be r ef l ect ed i n st ock pr i ces w ell bef or e i t occu r s -
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2 Research Article
t hi s i s essent iall y t he not io n t hat st ock pr ices ar e a leadi ng indi cat o r f or t he w ell -bein g of t he economy. Second , chan ges
i n di scoun t r at es may af fect st ock p r i ces an d real i n vest m ent si mil ar l y, but t he out put f r om r eal in vest ment does not
appear f or some t ime af t er i t i s made. Thi r d, changes in st ock p r i ces ar e changes i n weal t h , and t hi s can af f ect t h e
demand fo r consumpt i on and invest men t good s [ 8] .
Th e main obj ect ive of t hi s paper w as t o i nvest i gat e t he cau sal r elat i on sh ip among eco nomi c gr ow t h, st ock mar ket
developmen t and bank l en ding. St ock mar ket d evel opment and bank l endi ng favou r economi c gr ow t h.
Sect i on 2 descr ibes t h e sp ecif i cat i on of t h e model , devel op s t he Johansen co -i nt egrat i on analysi s, anal yses t he vect or
er r or cor r ect i on models and pr esen t s Gr anger causal it y t est s, w hi l e sect io n 3 pr esent s t h e empi r ical r esul t s. Fi nal l y,
sect i on 5 p ro vi des t h e concl u si ons of t hi s paper sin ce onl y a shor t d iscu ssion summar i zes in sect i on 4.
2. Dat a and specif icat ion model
2. 1. Dat a analysis:
In t h is st udy, t h e met hodol ogy of vect or aut or egr essive model (VAR) is app li ed t o est i mat e t he r elat ionshi p amon g
econ omi c gr ow t h, st ock mar ket developmen t and bank l en ding.
Suppose t hat a gener al vect or mod el can b e est i mat ed separ at el y, r egar di ng each var iabl e as a d ep end ent one w i t h
ot her t w o i ndependen t var iabl es r espect ivel y.
V = f (SM , GDP, BC) (2.1)
w here, SM i s t he general st ock mar ket i ndex; GDP i s t he gr oss do mest i c pr od uct ; BC is t he ban k lendin g exp r essed by
bank credi t s t o p r i vat e sect or .
Acco rd in g t o t he empi r i cal st udi es of King and Levine; Vazakid i s and Adamopoulos [ 9, 10, 11] , t he var iabl e o f economi c
gr ow t h (GDP) i s measur ed by t he r at e of change of r eal GDP, wh i le t he gen er al st o ck mar ket index is used as a pr oxy f or
t he st ock mar ket d evelopment . Th e gener al st ock mar ket i ndex (SM ) b et t er r epr esent s t he st ock exchan ge market t han
ot her f inancial in di ces [ 12, 13, 14, 15, 16, 17, 18] .
Th e sampl e used i n t hi s paper consist s of annual obser vat i on s f or Ger many and spans f ro m 1965 t o 2007 regar di ng 2000
as a base year . Al l t i me-ser i es dat a ar e expr essed i n t h ei r l evel s and ar e obt ai ned f r om Int er nat i onal Financi al St at ist i cs
[ 19] . The l i near mod el is sel ect ed as a bet t er model f or st at i st i cal est imat i on s t han a logar i t hmic o ne. Th e t est ed r esul t s
of t h e l ogar i t hmi c mod el have pr oved t o be st at i st i cal i nf er i or .
2. 2. Unit root t est s: For un ivar i at e t i me-ser i es, analysi s in vo lving st ochast ic t r ends, Augment ed Di ckey-Ful l er (ADF),
Ph il l i ps-Per r on (PP) and Kw iat kow ski et al (KPSS) [ 25] uni t r oo t t est s ar e cal cul at ed f or ind ividual ser i es t o pr ovide
evi dence as t o w het her t h e var iabl es ar e i nt egr at ed . Th is i s f o ll ow ed by a mul t i var iat e co -int egrat i on anal ysi s.
Augment ed Di ckey-Ful ler uni t r oo t t est s ar e calculat ed f or i nd ividual ser i es t o pr ovid e evidence as t o w het her t he
var iabl es ar e st at i onar y and i nt egrat ed of t he same o rder . Following the study of Seddighi et al [39] Augmen t ed
Di ckey-Ful l er (ADF) t est i nvol ves t he est i mat i on o f on e of t he fo ll ow i ng equat i ons r espect i vel y:
X
t
=
X
t-1
+
=
+ AX
p
j
t j t j
1
(2.2a)
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3 Business and Economics Journal, Volume 2010: BEJ-1
X
t
=
0
+
X
t-1
+
=
+ AX
p
j
t j t j
1
(2.2b)
X
t
=
0
+
1
t +
X
t-1
+
=
+ AX
p
j
t j t j
1
(2.2c)
Th e add i t i onal l agged t er ms ar e al so incl ud ed t o ensur e t hat t h e er ro r s ar e unco r r el at ed . Th e maxi mum l ag l en gt h
begi ns w it h 2 lags and pr oceed s down t o t he app ro pr iat e l ag by examin in g t h e AIC and SC i nf or mat ion cr i t er i a.
Th e nu ll hypot hesi s def i nes t hat t h e var iab le X
t
i s a non-st at i onar y ser i es (H
0
: =0) and i s r ej ect ed when i s si gni f i cant l y
negat i ve (Ha: <0). If t he cal cu lat ed ADF st at ist i c i s h igher t han M cKi nnon s cr i t i cal values, t hen t h e nu ll hypot hesi s (H
0
)
i s no t r ej ect ed and t he ser i es is non -st at i onar y or not i nt egrat ed of or der zer o I(0). Al t er nat i vely, r ej ect i on o f t he nu ll
hypo t hesi s i mpl i es st at io nar i t y. Fai lu r e t o r ej ect t he nu ll hypot hesi s l eads t o conduct i ng t he t est on t he d if f er ence of t h e
ser ies, so f ur t her d if f er enci ng i s conduct ed unt i l st at i onar it y i s r eached and t he nul l hypot hesi s i s r ej ect ed [ 20] .
In or der t o f i nd t he pr oper st r uct ur e of t he ADF equat i ons, i n t er ms of t h e in clusi on i n t h e equat i ons of an int er cep t (
0
)
and a t r end (t ) and i n t er ms of how many ext r a augment ed l agged t erms t o include i n t he ADF equat i ons, f or el imi n at ing
po ssib l e aut ocor r elat i o n in t he d i st ur bances, t he min imum val ues of Akai ke, Schwar z [ 21, 22] cr i t er io n (SC) based on t h e
usual Lagr an ge mul t ip li er LM (1) t est w er e employed . The Evi ew s economet r i c sof t war e package, whi ch i s used t o
conduct t h e ADF, PP, KPSS t est s, r epor t s t h e si mulat ed cr it i cal val ues based on r esponse sur faces.
Ph il l i ps and Per r on [ 23] t est is an ext ension of t he Dickey-Ful l er (DF) t est , w hi ch makes t h e semi-paramet r i c cor r ect ion
f or aut oco r r el at i on and is mo re r obust in t he case of w eak aut oco r r elat i on and het er oskedast ic r egr ession r esi dual s.
Acco rd in g t o Choi [ 24] , t he Ph i ll i ps-Per r on t est appear s t o b e mor e pow er fu l t han t he ADF t est f o r t he aggr egat e dat a.
Al t hough t he Phi ll i ps-Per r on (PP) t est gives d if f er ent lag pr of i les f or t he examin ed var i abl es (t i me-ser ies) and somet i mes
i n l ow er levels of si gni f ican ce, t he mai n concl usio n is qual it at i vel y t he same as r epo r t ed b y t he Di ckey-Ful l er (DF) t est .
Si nce t he nul l hypo t hesi s i n t he Au gment ed Di ckey-Ful l er t est i s t hat a t i me-ser ies cont ains a uni t r oo t , t h is h ypot hesi s i s
accept ed unl ess t h er e i s st r o ng evidence again st it . How ever , t hi s appr oach may be l ess ef f ect i ve again st st at io nary near
un it r o ot p rocesses. Kw i at ko w ski et al [ 25] p r esen t a t est w her e t he nul l hypo t hesi s st at es t hat t h e ser i es i s st at i onar y.
Th e KPSS t est co mpl ement s t he Augmen t ed Di ckey-Fuller t est i n t h at concer ns r egar di ng t he pow er of ei t h er t est can b e
addr essed b y co mpar ing t he si gni f i cance of st at i st i cs f r om bot h t est s. A st at i o nar y ser i es has si gni f ican t Augmen t ed
Di ckey-Ful l er st at i st i cs and i nsi gni f ican t KPSS
1
st at i st ics. The KPSS st at ist ic t est s f o r a r elat ive lag-t r uncat i on par amet er
1
Following the studies of Chang [37], Dritsakis and Adamopoulos [30], according to Kwiatkowski et al [25], the test of PSS assumes that a time-series can be
composed into three components, a deterministic time trend, a random walk and a stationary error:
yt = t + rt + t
where rt is a random walk rt = rt-1 + ut.. The ut is iid (0,
2
u
).
The stationarity hypothesis implies that
2
u
=0.
Under the null, yt, is stationary around a constant (=0) or trend-stationary ( = 0). In practice, one simply runs a regression of yt over a constant (in the case of level-
stationarity) ore a constant plus a time trend (in the case of trend-stationary). Using the residuals, ei , from this regression, one computes the LM statistic
=
T
t
t t
S S T LM
1
2 2 2
/
where
2
t
S
trace
(r) = -T
+ =
p
r i
i
1
) 1 ln(
(2.3a)
w here =
i
i s t he l ar gest est i mat ed val ue of it h char act er i st i c r oot (eigenval ue) obt ai ned f r om t h e est i mat ed mat r i x, r
= 0, 1, 2,.p-1, and T is t he numb er o f usab le obser vat i on s.
=
=
t
i
i t
e S
1
, t = 1,2,T
The distribution of LM is non-standard: the test is an upper tail test and limiting values are provided by Kwiatkowski et al [25], via Monte Carlo simulation. To allow
weaker assumptions about the behaviour of t, one can rely, following Phillips [31] and Newey and Wests [32] estimate of the long-run variance of t which is defined
as:
= = + =
+ =
T
t
l
s
T
s t
k i i i
e e l s w T e T l S
1 1 1
1 2 1 2
) , ( 2 ) (
where w(s,l) = 1 - s / (l+1). In this case the test becomes
=
T
t
t
l S S T
1
2 2 2
) ( /
which is the one considered here. Obviously the value of the test will depend upon the choice of the lag truncation parameter, l. Here we use the sample
autocorrelation function of et to determine the maximum value of the lag length l.
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5 Business and Economics Journal, Volume 2010: BEJ-1
Th e
t r ace
st at i st i c t est s t he nu ll hypot hesi s t hat t he number of d ist inct charact er ist i c r oot s i s l ess t h an or equal t o r,
(w her e r i s 0, 1, or 2,) again st t he general al t er nat i ve. In t hi s st at i st i c,
t r ace
w i l l b e smal l w hen t he val ues o f t he
char act er i st i c r oot s ar e cl oser t o zero (and it s value w i l l be l ar ge in r elat io n t o t he values of t he char act er i st i c r oot s,
w hi ch ar e f ur t her f r o m zer o).
Al t er nat i vely, t he maxi mum ei gen value (
max
) st at i st i c as suggest ed b y Johansen i s
max
(r, r+1) = -T ln(1-
1 + r
) (2.3b)
Th e
max
st at ist ic t est s t h e nul l hypot hesi s t hat t he number o f r co-in t egr at ed vect or s i s r again st t he al t er nat ive of (r +1)
co -in t egr at ed vect or s. Thus, t he nul l hypot hesi s r =0 i s t est ed again st t he al t er nat ive t hat r =1, r =1 again st t he al t ernat i ve
r =2, and so f or t h . If t he est i mat ed val ue of t h e char act er i st i c r o ot i s cl ose t o zer o, t hen t he
max
w i ll be smal l .
It i s w el l known t hat Johan sen s co -i nt egrat i on t est s ar e ver y sen si t ive t o t he cho ice of lag l engt h . Fir st l y, a VAR model is
f it t ed t o t h e t i me-ser i es dat a i n or der t o f i nd an appropr iat e lag st ruct ur e. The Sch war z Cr i t er i on (SC) and t he l ikel i hood
r at io (LR) t est ar e used t o select t he number of lags r equi r ed i n t he co-int egr at i on t est . The Sch war z Cr i t er i on (SC) and
t he l i kel i hood rat i o (LR) t est suggest ed t hat t he value p =1 i s t he appr opr iat e sp ecif i cat i on f or t h e or der of VAR mod el f or
Ger many. Tabl e 2 pr esen t s t he r esul t s f r om t he Johansen and Jusel i ous [ 26, 29] co-i nt egr at i on t est .
2. 4. Vect or error correct ion model: Si nce t he var i ables incl ud ed in t he VAR mod el ar e found t o be co-in t egr at ed, t h e
next st ep is t o specif y and est i mat e a Vect or Er r or Cor r ect i on M o del (VECM ) incl ud in g t h e er r or cor r ect i on t er m t o
i nvest i gat e dynamic behavi our of t h e model. Once t h e equ il i br iu m condi t i on s ar e imposed, t h e VEC model descr ibes
ho w t h e exami ned model i s ad j ust i ng i n each p er iod t ow ar ds i t s l ong-run equ il i br i um st at e.
Si nce t he var iabl es ar e co-int egr at ed , so, i n t he sho r t r un , devi at i ons f r om t hi s l ong-r un equ il i br iu m w il l f eed back on t h e
chan ges in t he d ependent var iabl es in o rd er t o f o rce t h ei r movement s t owar ds t he l ong-run equ i li br i um st at e. Hence,
t he co -i nt egrat ed vect o r s f r om wh i ch t h e er r or cor r ect i on t er ms ar e der i ved ar e each indi cat i ng an indep end ent
di r ect i on wh er e a st abl e meaningf ul l ong-r un equi l i br i u m st at e exi st s.
Th e VEC speci f i cat io n fo r ces t he l ong-r un b ehavi ou r of t he endo genous var i abl es t o conver ge t o t hei r co-i nt egrat ed
r el at ionshi ps, w hich accommodat es shor t -run dynami cs. The dynamic speci f icat i on of t he model al l ow s t he del et i on of
t he i nsigni f icant var iab les, w hi l e t h e er ro r co r r ect i on t er m i s r et ai ned . Th e si ze of t he er r or cor r ect i on t er m i ndi cat es t h e
speed of adj ust ment o f any di sequi l ib r i um t oward s a long-r un equi l ib r i um st at e [ 28] . The er r or -cor r ect ion mod el w i t h
t he compu t ed t -values of t he r egression co ef f i cient s i n par en t heses i s r epor t ed in Tab le 3.
Th e f i nal f or m of t he Er r or -Cor r ect ion M odel (ECM ) w as sel ect ed acco rd ing t o t he appr oach suggest ed by Hend r y [ 33] .
Th e gener al f orm o f t he vect or er r or co r r ect i on model (VECM ) i s t h e f ol lo w ing on e:
t i t i t
n
i
n
i
n
i
i t i t t
EC Z + + A + AY + AX + = AX
3 2 1 0
(2.4)
w here is t he f i r st d if f er ence op er at or , EC
t -1
is t h e
er r o r co r r ect i on t er m lagged one per iod , i s t he shor t -r un coef f ici ent
of t h e er ro r co r r ect i on t er m (-1<<0),
t
i s t h e w hi t e no ise t er m.
2. 5. Granger causalit y t est s: Gr anger causal i t y i s used f or t est i ng t he l ong-r un r elat i onshi p bet w een st ock mar ket
developmen t and economi c gro w t h . Th e Granger pr ocedu r e i s sel ect ed because i t con si st s t he mor e pow er f u l and
simp ler way of t est in g causal r el at i onship [ 34] . The f ol l ow i ng bi var iat e mod el is est i mat ed :
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6 Research Article
t
k
j
j t j j t
k
j
j t
u X b Y a a Y + + + =
=
= 1
1
1
1 10
(2.5a)
t
k
j
j t j j t
k
j
j t
u Y b X a a X + + + =
=
= 1
2
1
2 20
(2.5b)
w here Y
t
i s t he dependent and X
t
i s t h e expl anat o r y var iabl e and u
t
is a zer o mean whi t e noi se er ro r t er m i n Eq (2.5a),
w hi l e X
t
i s t h e dependent and Y
t
i s t h e explanat or y var iab le in Eq (2.5b).
In or der t o t est t he above hypo t heses t he usual Wald F-st at ist i c t est i s ut i li sed, w hi ch has t h e fo ll ow ing f o rm
) 1 2 /(
/ ) (
=
q T RSS
q RSS RSS
F
U
U R
w here
RSS
U
= i s t h e su m of squar ed r esidual s f r o m t he comp l et e (u nr est r ict ed) equat ion
RSS
R
= t he su m o f squar ed r esi dual s f ro m t he equat i on und er t he assumpt i on t hat a set of var i abl es i s r edundan t , when
t he r est r ict io ns ar e i mpo sed, (r est r ict ed equat i on )
T = t he samp le si ze and q = i s t he lag l engt h .
Th e hypot heses in t h is t est ar e t he f o ll ow in g:
H
0
: X d oes not Gr anger cau se Y, i .e. {
11
,
12
,...
1k
}=0, i f F
c
< cr it i cal val ue of F
.
H
a
: X d oes Gr anger cau se Y, i .e. {
11
,
12
,.
1k
}0, if F
c
> cr it i cal value of F. (2.6a)
and
H
0
: Y d oes not Gr anger cau se X, i .e. {
21
,
22
,...
2k
}=0, i f F
c
< cr i t ical value of F.
H
a
: Y d oes Gr anger cau se X, i .e. {
21
,
22
,.
2k
}0, if F
c
> cr i t i cal val ue o f F. (2.6b)
[ 35] .
Th e r esul t s r elat ed t o t he exi st ence o f Granger cau sal r elat i on sh ip s amon g economic gr ow t h, st ock mar ket
developmen t , and ban k l end i ng ar e pr esen t ed i n Tab l e 4.
3. Empirical re sult s
Th e ob ser ved t -st at i st i cs in t he t ab le 1 f ai l t o r ej ect t he nu ll hypot hesi s o f t h e pr esence of a uni t r oo t f or all var iab les i n
t hei r l evel s conf i r mi ng t hat t hey ar e non -st at i onar y at 1% and 5% levels of signi f icance. Th e comb i ned r esul t s (ADF, PP,
KPSS) f rom all t est s show t hat t he nul l h ypo t h esis of t he pr esen ce o f a un it r oot i s r ej ect ed f or al l var iabl es w hen t hey
ar e t ransfo r med in t o t heir f i r st d if f er ences (Tabl e 1). Ther efo r e, al l ser i es t hat are used ar e non -st at i onar y i n t h ei r l evel s,
bu t st at i onar y in t hei r f i r st di f f er ences (in t egr at ed of or der one I(1). Ther efo r e, fo l lo w in g Dr it saki s and Adamopoul os
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7 Business and Economics Journal, Volume 2010: BEJ-1
[ 30] t h ese var iab les can be co-in t egr at ed as w el l , i f t her e ar e one or mor e li n ear comb inat i ons amon g t h e var iab les t hat
ar e st at i onar y.
Th e r esu lt s t hat appear i n Tabl e 2 su ggest t hat t he number o f st at i st i cal l y signi f i cant co-i nt egrat i on vect o r s f or Ger man y
i s eq ual t o 1. The p rocess of est i mat i ng t he r an k r i s r el at ed w i t h t he assessm ent of eigenval ues, whi ch ar e t h e fo ll ow in g
f or Ger many: =
1
0.3755, =
2
0.1689, and =
3