Stock Markets, Banks and Economic Growth in a Context of Common Shocks and Cross-Country Dependencies

Diego Ivan Ruge Leiva and Giuseppe Caivano ()
Authors registered in the RePEc Author Service: Diego-Ivan Ruge-Leiva

No 03/17, Working Papers from Instituto Universitario de Análisis Económico y Social

Abstract: Although a great deal of research has shown how stock markets and banks may relate to economic growth, such studies ignore the role that common shocks play in the finance-growth nexus. Using panels of 54 advanced and emerging economies, and novel common factor frameworks which account for dynamics, reverse causality, observed heterogeneities, and unobserved common shocks which cause error cross-sectional dependencies across countries, we find that stock market development has positive long-term effects on economic growth, while high levels of banking development might be detrimental to overall output. These results also hold for a subsample of advanced countries; however, despite the positive and significant effect that stock market development has on growth for a subsample of emerging countries, the negative effect of bank development is as likely to be significant as insignificant in this case. Moreover, we find that ignoring the strong error cross-sectional dependencies caused by common shocks and/or assuming homogeneous coefficients may yield inconsistent estimates.

Keywords: Economic Growth; Stock Market Development; Banking Development; Cross-Section Dependence; Multifactor Error Structure. (search for similar items in EconPapers)
Pages: 46 pages
Date: 2017-05
New Economics Papers: this item is included in nep-fdg and nep-gro
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