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299

ANALYSIS FOR BANGLADESH ECONOMY

MD. SHARIF HOSSAIN (PH. D.)1 - KHND. MD. MOSTAFA KAMAL2

Abstract

In this paper the principal purpose has been made to investigate the causal relationship between stock market development and

economic growth in Bangladesh. To investigate long-run causal linkages between stock market development and economic growth

the Engle-Granger causality and ML tests are applied. In this paper another attempt has been made to investigate the non-stationarity

in the series of stock market development and economic growth by using modern econometric techniques. The co-integrated tests are

applied to know whether this pair of variables shares the same stochastic trend or not. From our analysis it has been found that the

stock market development strongly influences the economic growth in Bangladesh economy, but there is no causation from economic

growth to stock market development. Thus unidirectional causality has prevailed between stock market development and economic

growth in the Bangladesh economy. Also it has been found that all the variables are integrated of order 1, and both the variables stock

market development and economic growth share the same stochastic trend in Bangladesh economy.

JEL Code: C010

Key Words: Stock Market Development, Causal Relationship, Non-stationarity, Unit Root Test, Co-integrated Tests

Introduction

Stock market development plays an important role for economic growth in the developed and developing countries. Shahbaz et.

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 to

economic 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 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.

Stock markets are very important because they play a significant role in the economy by changing investment where it is needed

and can be putted to best ( Liberman and Fergusson 1988). The stock markets are working as the channel through which the public

savings are mobilized to industries and business enterprises. Mobilization of such resources for investment is certainly a necessary

condition for economic take off, but quality of their allocation to various investment projects is an important factor for economic

growth. This is precisely what an efficient stock market does to the economy ( Berthelemy and Varoudaks 1996).

During nineteenth and twenty century, Bagehot (1973) and Schumpeter (1912) had focused on the constructive assistance of financial

sector to economic growth. In the study, the direction of causality between the higher growth in financial sector and countrys economic

growth rate was not clear ( Robinson believed that there is no correlation between stock market development and economic growth

because of the presence of level effect

not the rate effect. Similarly Singh (1997) contended that stock markets are not necessary institutions for achieving high levels of

economic development. Many viewed stock market as a agent that harm economic development due to their susceptibility to market

failure, which is often manifest in the volatile nature of stock markets in many developing countries (Singh, 1997; Singh and Weis,

1999). So, the traditional assessment model of stock prices and the wealth effect provide hypothetical explanation for stock process to

be proceeded as an indicator of output (Comincioli, 1996). According to wealth effect, however, changes in stock prices cause the

variation in real economy ( Bhide, 1993; and Obstfeld, 1994).

Contrary to traditional views; a large number of theoretical and empirical works have been done in order to understanding the

strong positive linkage between stock market development and economic growth. See for example likes Shahbaz, Ahmed and Ali

(2008) has found a long run relationship between stock market development and economic growth. Stock market development has

the direct impact in corporate finance and economic development. Deb and Mukherjee (2008) have found a bi-directional causality

between real GDP growth rate and real market capitalization ratio in the Indian Economy. Adjasi and Biekpe (2005) found a

significant positive impact of stock market development on economic growth in countries classified as upper middle income

economies. In the same way, Chen et al (2004) elaborated that the nexus between stock returns and output growth and the rate of

stock returns is a leading indicator of output growth. Arestic et al (2001) using time series on five industrialized countries also

indicate that stock markets play an important role for economic growth. Various studies such as Spears (1991); King and Levin

1

Associate Professor of Econometrics, Department of Economic Engineering, Faculty of Economics, Kyushu University, Japan, E-mail:

sharif@en.kyushu-u.ac.jp, sharif_hossain04@yahoo.com

2

Lecturer, Department of Statistics, Biostatistics and Informatics, University of Dhaka, Bangladesh, E-mail: mostafastat@yahoo.com

300

(1993a, b), Levin and Zervos (1998), Atje and Jovanovic (1993), Comincioli (1996), Filer et al (1999), and Demirguc and

Maksimovic (1996), have found positive association between financial development on economic growth. by real market

capitalization ratio (size proxy) defined by the ratio of market capitalization to real GDP. These studies largely based on developed

and developing countries. Only few studies have been conducted for less developed/underdeveloped countries. In Bangladesh the

development and growth of stock markets have been widespread in recent times. The stock market development could have important

implications for economic activity. Pardy (1992) has noted that even in less developed countries capital market are able to mobilize

domestic savings and able to allocate funds more efficiently. Thus stock market can play an important role in inducing economic

growth in Bangladesh by channeling investment where it needed from public. Mobilizing of such resources to various sectors

certainly helps in economic development and growth. According to the knowledge of authors, in Bangladesh economy no one

conducted any study in order to investigate the causal linkage between stock market development and economic growth. That is why,

in this paper the principal purpose has been made to investigate the causal relationship between stock market development and

economic growth in Bangladesh. In this paper another attempt has been made to investigate the non-stationarity in the series of stock

market development and economic growth by using modern econometric techniques. The co-integrated tests are applied to know

whether the pair of variables shares the same stochastic trend or not.

Data Measurement

This study focuses on the Bangladesh economy spanning over a time period of about 33 years from 1976 to 2008. This study is

based on secondary dada which are collected from annual reports and official reports Trends published by the Statistics Department of

Banglad of Dhaka Stock Exchange (DSE) and website of Securities & Exchange Commission (SEC) of Bangladesh, Statistical Yearbooks of

Bangladesh. The variables we have used are as follows:

1. Economic development is measured by the growth rate of real GDP at constant market price (base year: 1995-96 = 100) and

also by the real per capita GDP

2. Stock market development is measured by real market capitalization ratio (size proxy) defined by the ratio of market

capitalization to real GDP and also by the market capitalization.

3

Graphical Method

In order to study the existing upward trending of these considered variables, these series are presented graphically below in

logarithmic form

Figure 1: Per Capita Real GDP, Growth Rate of Real GDP, Market Capitalization and Ratio of Market Capitalization to Real

GDP in Logarithmic3

LPCAP

7.8

7.7

7.6

7.5

7.4

7.3

7.2

7.1

7.0

6.9

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

1994

1997

2000

2003

2006

LMCAP

12

11

10

1976

1979

1982

1985

1988

1991

LGRATE

2.00

1.75

1.50

1.25

1.00

0.75

0.50

0.25

0.00

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

1994

1997

2000

2003

2006

LMCR

3.6

2.4

1.2

0.0

-1.2

-2.4

-3.6

1976

1979

1982

1985

1988

1991

null

hypothesis

is that the

From the above figure, it is clear to us all of these true

variables contain upward trend and this trend is process is

unmistakable. Now the most important question arise inrandom

our mind, whether this tend arises positive drift or not. walk with

From the point of economic theory, all of these figures trend. Now

should exit a deterministic time trend and so a natural for

verification

of this null

hypothesis

for

each

and every3

LPACP : Per capita real GDP in logarithmic, LGRATE:

variable, Growth

rate of real GDP in logarithmic, LMCP : Market

next

thecapitalization in logarithmic, and LMCR : Market

capitalization ratio to real GDP in logarithmic

modern

301

Econometric Analysis

the stock market development causes economic growth in

Bangladesh economy. Before doing this an econometric

analysis has been done to test whether stock market

development and economic growth contains a unit root or not

and whether an underlying co-integration relation exists. If

both the series does not contain a unit root then any innovation

to the series are temporary and have short-run consequences.

Otherwise, any shocks to it will be permanent and thus have a

long-run effect. To test for the stationarity of a variable a

number of econometric techniques have been developed which

are called unit root tests.

4.1

analysis can result in highly misleading conclusion when

variables contains stochastic trend (Stock and Watson (1988),

Granger and Newbold (1974)). In particular if the dependent

variable and at least one independent variable contain

stochastic trend, and if they are not co-integrated, the

regression results are spurious, (Phillips (1986), Granger and

Newbold (1974)). To identify the correct specification of the

model, an investigation of the presence of stochastic trend in

the variables is needed. To test for the stationarity of economic

growth, and stock market development a number of

econometric techniques have been employed. The DickeyFuller, and Augmented Dickey-Fuller tests are applied in order

to investigate that each of the variables contains stochastic

trend or not.

For the DickeyFuller test, the

following three

cases have been

considered in this

paper; Case

One: Constant

and trend terms

are included in

the equation

= + t + X + u

0

t-1

in the equation

m

= + t + X +

0

t-1

X + u t

t-i

i=1

= + X

0

t-1

+i X + u t

t-i

i=1

Case Three: No trend and constant terms are included in the equatio

= X

t-1

i=1

m

i

X + u

t-i

difference and the lagged difference terms on the right hand side

of the equations are designed to correct for serial correlations of

the disturbance terms. The lagged differences are selected by

using the AIC and SBIC criteria. If = 0, the series Xt contains

a unit root and therefore an I(1) process governed by a

stochastic trend.

Since the estimated does not have the usual asymptotic

distribution, the values tabulated by MacKinnon (1991) are

used; these values are more accurate than the ones original

tabulated by Fuller (1976) and Dickey-Fuller (1987). We can

also use the PhillipsPerron test. Phillips and Perron (1988) generalized the following

results, to the case when the random error term ut is serially

correlated and possibly heteroscedastic as well. The PhillipsPerron test for the null hypothesis H0 : 1, i.e. H0 : 1

0, is given by;

1

Z

T 1

t

1

0

T

u; s

t 1

2

t

T 2

T

u ;

2

t

t 1

unit root tests, the Dickey Fuller, the Augmented Dickey Fuller

and the Philips-Perron tests results are reported below;

t

t

0

t-1

Case Three: No constant and trend terms are included in the equation

Table 1: The Dickey-Fuller (DF), Augmented Dickey-Fuller

Xt = Xt-1 + ut

(ADF) and Philips-Perron (PP) Tests Results4

and for the

DF Test

ADF Test

Augmented

Dickey-Fuller Test,

4

the following

All the variables are in logarithmic form

equations have

At

5% level of significance the critical values of DF and ADF tests for

been considered

case one is -3.584, for case two is -2.980 and for case three is -1.95. For

Case One :

Phillips-Perron test the critical value at 5% level of significance for case

Constant and trend

one is -18.204, for case two is -12.51 and for case three is -7.305

Case Two: Only constant term is included in the equation

= + X + u

jT

302

Case1

Case 2

Case 3

Case 1

Case 2

Case 3

Case 1

Case 2

Case 3

PCGDP

-1.61914 7.89294

8.34003

-1.75831 2.45207

1.96013

-1.3322

2.0023

0.1171

GRATE

-3.55933 -2.96291

0.19673

-2.49901 -1.85249 0.43433

-15.8836 -8.4271

0.3568

MCAP

-1.81494 -0.02855

3.72257

-2.86618 -0.46862 1.92911

-9.6252

-0.1576

1.0372

MCAR

-1.77592 -0.26729

-0.47102 -2.76028 -0.70467 -0.86513

-9.0945

-0.4797

-1.0807

Results Discussion: To examine the order of integration here the DF, the ADF and PP tests are applied to the variables per

capita real GDP (PCGDP), growth rate of real GDP (GRATE), total market capitalization (MCAP) and ratio of market

capitalization to real GDP (MCAR). From the estimated results of these three tests, it has been found that for all variables, the null

hypothesis of unit root can not be rejected at 5% level of significance. Thus it can be concluded that all the variables are nonstationary. Thus, the innovation of these series will be permanent and have a long-run effect for economic development in

Bangladesh economy.

Also, it is very much necessary to enquiry the second order unit root in each series. The test results for the second order unit

root are reported below;

Table 2: The Dickey-Fuller (DF), Augmented Dickey-Fuller (ADF) and Philips-Perron (PP) Tests Results for 2 nd Order Unit

Root 5

DF Test

ADF Test

PP Test

Case1

Case 2

Case 3

Case 1

Case 2

Case 3

Case 1

Case 2

Case 3

PCGDP -4.3844* -4.9218* 3.6970* 2.2826**

4.3536* 2.0699** 26.7848** 14.8666** 10.1636*

GRATE -7.3047* -7.3385* -5.9808* -5.0346* -40.8074* -40.3329* 7.3806*

5.4913*

39.5603*

MCAP

-2.6463* 3.7878** 3.8557* 2.89357* 3.8918** 3.9693*

22.8793** 22.7684** 14.7232*

MCAR -3.1452* -2.944*

-22.8290* 3.7921** 3.8632*

3.8967** 3.9704*

22.8948**

16.8294*

Results Discussions: From the tests results it has been found that all the series do not contain second unit root. So, from the

results it can be concluded that all the series are integrated of order one that is I(1). Next, the co-integrating relationship between

different pairs of variables has been discussed for Granger causality investigation.

4.2

Co-integration Tests

The preceding analysis helps to make the point that the series, per capita real GDP, growth rate of real GDP, market

capitalization and ratio of market capitalization to GDP are non-stationary which means that each series individually contains unit

root. But, the questions is, either these series share a common trend, so that the gap will not grow without bound. Therefore, I have

further conducted an alternative analysis by using the co-integration techniques. The notion of co-integration among variables has

introduced a new flexibility into the modelling of economic time series. As defined by Engle and Granger (1987), two variables

are co - integrated of order (1, 1), if each variable individually is stationary in first differences (integrated of order 1), but linear

combination of the variables is stationary in level (integrated of order 0). More generally, a set of variables is co-integrated of

order (d, b) if each variable individually is integrated of order d, but at least one linear combination exists which is of order (d-b).

Most of the researchers focuses on the case d =1 and b = 1 and I have done the same here. Here I have also conducted the DF, ADF

and PP tests for the second unit root, the results are reported in Table 2, all the tests results indicate the rejection of second unit root

in each series. Thus it is very much clear that all the series are I(1) processes and thus it is appropriate to carry out the cointegration analysis. To test for co-integration, the Engle-Granger (1987) and Phillips and Ouliaris test (1990) methods are applied.

The co-integrated tests results for different pairs of series are given with the following table;

Table 3: Residual-Based Tests Results for Co-integration between Different Pairs of Variables 6

Engle-Granger Test

Phillips-Ouliaris Test

Case One

Case Two

Case Three

Case One

Case Two

Case Three

Dependent Variable Per Capita Real GDP (PCGDP), Independent Variable Market Capitalization (MCAP)

-1.44623

-1.05985

-1.42942

-5.0843

-3.4416

-1.8109

Dependent Variable Per Capita Real GDP (PCGDP), Independent Variable Market Capitalization Ratio to GDP (MCR)

-1.53468

-0.96490

2.02668

-5.8240

-3.3399

0.0995

Dependent Variable Growth Rate of GDP (GRATE), Independent Variable Market Capitalization (MCAP)

-3.53839

-2.89408

-1.27061

-19.2832

-19.8095

-14.3875

Dependent Variable Growth Rate of GDP (GRATE), Independent Variable Ratio of Market Capitalization to GDP (MCR)

-3.55864

-2.59711

-0.30985

-19.4389

-19.9231

-0.2021

Dependent Variable Market Capitalization (MCAP), Independent Variable Per Capita GDP (PCGDP)

-2.04068

-1.76578

-0.54722

-11.4283

-5.0411

-0.9889

5

6

The critical values for Augmented Engle-Granger test at 5% level of significance is -3.588 for case one, -2.9828 for case two, and -1.95 for case

three, and for Phillips-Ouliaris test the critical values at 5% level of significance is -27.1 for case one, -21.5 for case two, and -15.6 for case three.

Case one: indicates constant and trend terms are included in the equation, Case two : indicates only constant term is included in the model, Case

three : no constant and trend terms are included in the model.

International Conference On Applied Economics ICOAE 2010

303

Dependent Variable Market Capitalization (MCAP), Independent Variable Growth Rate of GDP (GRATE)

-1.87054

-2.28320

-3.17365

-9.3748

-11.3028

-16.9852

Dependent Variable Market Capitalization Ratio to GDP (MCR), Independent Variable Per Capita GDP (PCGDP)

-2.06357

-1.71357

-0.48608

-11.5276

-5.1866

-0.9856

Dependent Variable Market Capitalization Ratio to GDP (MCR), Independent Variable Growth Rate of GDP (GRATE)

-1.84527

-2.33340

-0.89884

-8.9892

-11.7461

-1.5117

Results Discussion: From both the Engle-Granger and Phillips and Ouliaris tests results it has been found that all the pairs of

variables are co-integrated with each other. Thus it can be said that these pairs of series share the same stochastic trend. Therefore

it can be concluded that there is a long-run equilibrium relationship between stock market development and economic growth in

Bangladesh economy. Thus it can be said that the pairs of variables stock market development and economic growth bear the

mutual dependence for the economic development.

4.3

In order to investigate the causal directions associated with the change of stock market development and economic growth, the

Granger causality test and the Lagrange Multiplier Test are applied. Prior to the causality test, examined the order of integration for

all variables by the unit roots tests. In section (1) the DF, ADF and PP tests results have been presented, which indicate the possible

I(1) property for all the variables. After that the co-integration relationship between different pairs of series has been examined,

which are used for the causality test. It has been found that the all pairs of variables are co-integrated to each other. Therefore, the

following equation for the Granger Causality test is used;

= + X

0 it-i

i=1

n

j

j=1

Y + u

t-j

(8

Here, moreover, 2 different lags has been considered in equation (8) i.e. n=m= 1, 2. Our decision for taking 2 continuous lags is

somewhat conventional. We have also investigated the casual direction for higher lag values but, there is no causal relationship

between the variables for higher lag values that is why the test results are not reported for higher lag values. The estimated values

are reported with the following table;

Table 4: Granger Causality Test Results 7

Granger F-Test

Lagrange Multiplier Test

Per Capita Real GDP (PCGDP) versus Market Capitalization (MCAP)

Lag

1

2

R

Test Value

p-Value

Test Value

p-value

AIC

10.20961*

0.00335896

0.998407

8.33233*

0.0038945

-186.6924

2.24082

0.12651866

0.998688

4.557856

0.1023939

-179.3922

Per Capita Real GDP (GCGDP) versus Market Capitalization Ratio to GDP (MCAP)

SBIC

-182.2952

-172.2222

1

2

9.24913*

1.97559

0.00496014

0.998407

8.332331*

0.0038945

-185.8988

0.15895437

0.998861

4.089540

0.1294099

-178.8479

Growth Rate of Real GDP (GRATE) versus Market Capitalization (MCAP)

1

2

5.04725**

0.03244754

0.683428

4.743757**

0.0294047

17.36080

1.30607

0.28807100

0.717593

2.830137

0.2429089

19.81056

Growth Rate of Real GDP (GRATE) versus Market Capitalization Ratio to GDP (MCR)

-181.5016

-171.6780

21.75800

26.98050

1

2

Lag

12.14203*

1.30607

0.00158762

0.730357

9.443993*

0.00211842

17.36080

0.2880710

0.717593

2.830137

0.2429089

19.81056

Market Capitalization (MCAP) versus Per Capita Real GDP (PCGDP)

21.75800

26.98050

1

2

1.21870

2.40987

1.18867

0.2786915

0.978459

1.290542

0.2559481

48.11479

0.1096168

0.981742

4.847929

0.0885698

42.81366

Market Capitalization (MCAP) versus Growth Rate of Real GDP (GRATE)

52.51200

49.98360

0.2845752

0.978438

1.259987

0.2616535

48.14662

52.54382

2

AIC : Akaike Information Criterion, SBIC : Schwarz Bayesian Information Criterion, R : indicates goodness of fit, p- value : indicates the

lowest significance level at which a null hypothesis can be rejected, : means first difference, ** : indicates the statistical significant at 5% level

of significance, * : indicates the statistical significant at 1% level of significance.

304

International Conference On Applied Economics ICOAE 2010

1.46334

0.2499025

0.980547

3.136456

0.2084141

44.77878

Market Capitalization Ratio to GDP (MCR) versus Per Capita Real GDP (PCGDP)

1

2

1.24986

0.2727547

0.968508

1.322175

0.2502020

48.18928

2.48788

0.1026520

0.973493

4.979656

0.0829242

42.59196

Market Capitalization Ratio to GDP (MCR) versus Growth Rate of Real GDP (GRATE)

51.94871

52.58649

49.76189

1

1.36743

0.2517757

0.968630

1.440945

0.2299865

48.06515

52.46236

2

1.79308

0.1864243

0.972248

3.757528

0.1527788

44.01481

51.18475

The Granger Causality Test Results: The both tests results support that the stock market development causes the

economic growth significantly but the economic growth does not cause the stock market development in Bangladesh

economy. The results suggest the unidirectional causality from stock market development to economic in Bangladesh

economy. This association is statistically significant at any level of significance.

This paper has addressed the issue of long-run consequences between stock market development and economic growth

in Bangladesh economy. Here the real per capita income and growth rate of real GDP are as the indicators of economic

growth and the variables market capitalization and ratio of market capitalization to real GDP are used as the proxies of

stock market development. Here to know, whether the trend arises either from the positive drift term or not of a random

walk an empirical investigation has been done on the basis of the modern econometric techniques. First, using the DF, ADF

and PP tests, it has been found that the hypothesis of stationarity has not been rejected for all the series. Thus, it can be

concluded that any innovation of these series will be permanent and have a long-run effect for Bangladesh economy. The

test results support that these series do not contain second order unit root. Thus these series are integrated of order 1. In

order to find the co-integrated relationship between different pairs of variables, the Engle-Granger and Phillips and

Ouliaris tests have been applied. From the both tests results it has been found that all the pairs of variables are cointegrated with each other. Thus it can be said that variables stock market development and economic growth share the

same stochastic trend in Bangladesh economy. Therefore it can be concluded that there is a long-run equilibrium

relationship between stock market development and economic growth in Bangladesh economy. Thus it can be concluded

that the pair of variables bears the mutual dependence for economic development in Bangladesh. In this paper the Granger

causality test and the Lagrange Multiplier tests are applied to find the causal direction between stock market development

and economic growth

The both tests results support the unidirectional causality from stock market development to economic growth

significantly. But the relationship from economic growth to stock market development is insignificant. Thus finally it can

be concluded that stock market development significantly influences the economic growth in Bangladesh economy.

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