1. Advance Research Method
Review
Stock Market and its effect on growth of economy
Submitted to:
Dr Rashid Saeed
Submitted by:
Abdul Mannan
MBS 10-49
Bahauddin Zakariya University Sahiwal Campus
Department of Business Administration

2. The growing importance of stock markets around the world has opened a new opportunity of
research .The stock market is the common feature of modern economy and is expected to
promote economic and development of growth. Public as well as private sector operators make
use of various financial instruments to raise and invest short term funds which, if need be, can
be quickly liquidated to satisfy short-term needs. The Central Government, for instance, can
borrow money from the general public to finance long-term investment projects by issuing
treasury notes or bonds. The proceeds from the bonds issue can be used to build public
hospitals, construct roads, provide public transports, build airports, construct dams, or build
other social infrastructures. This entails national wealth creation for economic growth. Stock
market development plays an important role for economic growth in the developed and
developing countries. In the long run stock markets pays an important role. First spreading the
risk is the key role of stock market. Secondly imposing a degree of investment and with the
continuous monitoring on the share price.Shahbazet. al. (2008) argues that stock market
development is an important factor for economic growth as there is a long-run relationship
between stock market development and economic growth. Stock market development has the
direct impact in corporate finance and economic development. Gerald (2006) states that stock
market development is important because financial intermediation supports the investment
process by mobilizing household and foreign savings for investment by firms. It ensures that
these funds are allocated to the most productive ways and spreading risk and providing
liquidity so that firms can operate the new capacity efficiently. A growing body of literature
has expressed the importance of financial system to economic growth. Mishkin (2001) states
that an organized and managed stock market stimulate investment opportunities by
recognizing and financing productive projects and lead toeconomic activity, mobilize
domestic savings, allocate capital proficiency, help to diversify risks, and facilitate exchange
of goods and services. From the view point of Sharpe, et al (1999) stock market is a
mechanism through which the transaction of financial assets with life span of greater than
one year takes place. Financial assets may take different forms ranging from the long -term
government bonds to ordinary shares of various companies. Stock markets are the most
important institutions in the capital market where the shares of various companies are
traded. Trading of the shares may take place in two different forms of stock market . When
the issuing company sells its shares to the investors, the transaction is said to have taken

3. place in the primary market, when already issued shares of companies are traded among
investors the transaction is said to have taken place in the secondary market. Development
of financial market drives financial innovation, greater resource allocation, efficiency, and
technological advancement. Gregorio and Guidotti (1995), King and Levine (1993) have
found a strong positive correlation between stock market development and economic
growth. Goldsmith (1969); Mckinnon (1973) and Shaw (1973) initially hypothesize that
financial liberalization and stock market development would promote economic growth
through their impacts on the growth rate of savings, investment, and thus economic growth. This
is also called Mckinnon-Shaw model. The capital market has been identified as an institution that
contributes to the socio-economic growth and development of emerging and developed
economies. This is made possible through some of the vital roles played such as channeling
resources, promoting reforms to modernize the financial sectors, financial intermediation
capacity to link deficit to the surplus sector of the economy, and a veritable tool in the mobilization
and allocation of savings among competitive users which are critical to the growth and efficiency of
the economy (Alile 1994).
The functioning of the capital market affects liquidity, acquisition of information about firms, risk
diversification, savings mobilization and corporate control (Anyanwu 1998). Therefore,by
altering the quality of these services, the functioning of stock markets can alter the rate of
economic growth (Equakun 2005). It shows that about 69% of the systematic variation in the
dependent variable is explained by the four independent variables i.e. Market Capitalization
(MCAP), total New issues ( TNI), Value of transaction (VLT) and Bank total asset (BTA).
Market of West African monetary union (BRVM) is fairly new, established in 1998. However, it
is one of the best performing stock market in Africa. It is one of the seven stock markets which
trade automatically in Africa. We use two measures of stock market development namely SIZE
and LIQUIDITY. SIZE is denoted as market capitalization as a percentage of GDP. The
assumption behind this measure is that overall market size is positively correlated with the
ability to mobilize capital and diversify risk on an economy-wide basis. LIQUIDITY is
calculated as value of shares traded on the stock market exchange divided by GDP. The total
value traded ratio measures the organized trading of firm equity as a share of national output
and therefore should positively reflect liquidity on an economy-wide basis. . The total value

4. traded ratio complements the market capitalization ratio: although a market may be large, there
may be little trading.Greenwood and Smith (1997) show that large stock markets can decrease
the cost of mobilizing savings, thus facilitating investment in most productive technologies.
Bencivenga et al (1996) and Levine (1991) argue that stock market liquidity (the ability to
trade equity easily) is crucial for growth. Although many profitable investments require a long
run commitment of capital, savers do not like to relinquish control of their savings for long
periods. Liquid equity markets ease this tension by providing an asset to savers that they can
quickly and inexpensively sell. In principle, a well-developed stock market should increase
saving and efficiently allocate capital to productive investments, which leads to an increase in
the rate of economic growth. Stock markets contribute to the mobilisation of domestic savings
by enhancing the set of financial instruments available to savers to diversify their portfolios
(Dailami and Aktin, 1990).
The income that is not spent for consumption purpose is savings. Savings would then go
to form capital accumulation since savings are equal to investments (capital
accumulation is represented by investments) in a closed economy. Hence, savings in the
economy feeds into investment and net capital accumulation or the change in capital that
will contribute to output growth. In neo-classical growth models, the long-run rate of
growth is exogenously determined by either assuming a savings rate (Harrod-Domar
model) or a rate of technical progress (Solow model).
Whether there is a strong empirical association between stock market development and
long run economic growth Levine and Zervos (1996). They have defined and used some
key stock market development indicators; market capitalization ratio, liquidity ratio
(traded stock value/GDP) and turnover ratio (traded stock value/market capitalization) on
the assumption that these variables positively correlate with the ability to mobilize capital and
diversify risk.
Pakistan is an important but typical developing country. It is typical in the sense that most
developing countries are similar to each other with respect to some structural characteristics
related to their stages of economic and political development (Salahuddin and Islam,
2008). Most, including Pakistan and all its neighboring countries such as India, Bangladesh,
Maldives, Sri Lanka, Bhutan and Nepal, have been classified as low income and highly
indebted poor countries. With the exception of Sri Lanka and tiny states Maldives and

5. Bhutan, per capita income of all South Asian countries including Pakistan is less than
$1000 (World Development Indicators Database, 2007). The proportion of the population
living under the poverty line in these countries is also notable. It is also an important
country because of its nuclear capability. Maintaining peace and stability, not only in
Pakistan but also in the entire South Asian region, has become a priority issue to the world
super powers. Stock market in any country can be helpful for the growth of this country.
There exist a positive relation between stock market and growth. Pakistan has made a progress
in stock market. The three stock markets in Pakistan are Karachi, Lahore and Islamabad Stock
Exchanges. Our empirical results show its expected negative impact on economic growth. The
findings also emphasize the negative impact of higher inflation on economic growth. The
banking reforms launched in Pakistan in the last few years have reduced financial
instability. It is argued that, at the initial stages of economic development, the expansion of
stock markets increases both the opportunity for risk sharing and the flow of information in
the market. These, in turn, allow firms easy and cheap access to bank loans and increase the
level of leverage. However, at later stages as stock markets develop further, issuing equity
becomes more convenient because of declining costs, and firms substitute equity for debt.
The results are consistent with the findings that stock markets could impact economic growth.
There is positive relationship between stock market and economic growth. Results suggest a
positive relationship between several indicators of the stock market
performance and economic growth both directly

6. Refrences
Levine, R and Zervos, S., (1996), “Stock Market Development and Long Run Growth”, World
Bank Economic Review, Vol 10; pp 323 – 339
Gregorio, D. J. &Guidotti, P.E. (1995). Financial development and economic growth, World
Development 23:3,433–448. doi:10.1016/0305-750X(94)00132-I,
http://dx.doi.org/10.1016/0305-750X(94)00132-I .
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Brookings Institution
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Maturity Composition of the Capital Stock, Journal of Economic Theory, Springer, vol. 7(1). pp.
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Greenwood. J and Smith BD. (1997). Financial markets in development, and the development of
financial markets , Journal of Economic Dynamics and Control, Journal of Economic Dynamics
and Control ,Vol 21, pp.145-181.
Levine R. and Zervos S. (1998).Stock Market, Banks and Economic Growth. American Economic
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