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International Conference On Applied Economics ICOAE 2010

299

DOES STOCK MARKET DEVELOPMENT CAUSE ECONOMIC GROWTH? A TIME SERIES


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

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International Conference On Applied Economics ICOAE 2010

(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

empirical econometric techniques have been applied here.


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

International Conference On Applied Economics ICOAE 2010

301

Econometric Analysis

The principal econometric analysis involves testing whether


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

Unit Root Tests

It is well known that the usual techniques of regression


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

terms are included


in the equation
m

= + t + X +
0

t-1

X + u t

t-i

i=1

Case Two: Only constant term is included in the equation

= + 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

Here Xt is the series under investigation, stands for first


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

where the estimated autocovariances of the OLS residuals u'


t

1
0

T
u; s

t 1

2
t

T 2

T
u ;

2
t

t 1

To examine the order of integration for the variables by the


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

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International Conference On Applied Economics ICOAE 2010

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

*: indicates significant at 1% level, ** : indicates significant at 5% level

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

The Granger Causality Test

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)

H0 : Stock Market Development does not Granger cause Economic Growth


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

H0 : Stock Market Development does not Granger cause Economic Growth


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

H0 : Stock Market Development does not Granger cause Economic Growth


21.75800
26.98050

H0 : Stock Market Development does not Granger cause Economic Growth


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

H0 : Economic Growth does not Granger cause Stock Market Development


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

H0 : Economic Growth does not Granger cause Stock Market Development

0.2845752

0.978438

1.259987

0.2616535

48.14662

52.54382

All the variables are in logarithmic form


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.
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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

H0 : Economic Growth does not Granger cause Stock Market Development


52.58649
49.76189

H0 : Economic Growth does not Granger cause Stock Market Development


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.

Discussion and Conclusion

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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