SARKAR, AGNIRUP (2016) Dynamic General Equilibrium Analysis of Stock Market Behaviour in a Growing Economy. Doctoral thesis, Durham University.
The link between stock market activities and economic growth is a contentious topic in macro finance. A branch of the theoretical literature identifies stock markets as the main determinant of growth, while another branch links stock markets with the level or growth of per capita income of a nation. The second strand of literature, which mainly evolves from the Lucas (1978) asset pricing framework, models only the consumption side of the economy and establishes causality flowing from output or its growth to stock prices. Cochrane (1991) models only the production side but not the consumption side of the economy, which leads to a bi-directional flow of causality between stock prices and output growth. In reality, however, stock prices might not directly affect growth and vice versa and both can be simultaneously influenced by different exogenous factors. Brock (1982) looks into this issue by merging the partial equilibrium frameworks of the consumption and production based asset pricing approaches into a general equilibrium set-up.
However, there exists a distinct research gap in terms of exploring how stock market activities and growth are simultaneously influenced by various aggregate macroeconomic shocks. In my thesis, I address this research gap by investigating the simultaneous short run behaviour of stock market and growth due to different aggregate technology shocks within a Dynamic Stochastic General Equilibrium framework. In the theoretical frameworks that I use, growth occurs due to accumulation of a reproducible input which is physical capital and hence I essentially deal with endogenous growth models.
In Chapter 1 of my thesis, I first establish some stylized facts about the contemporaneous and lead-lag relationship between market capitalization ratio and growth. To investigate this, I look into annual data of 25 years on market capitalization as a ratio of GDP (as an indicator of stock market development) and growth of per capita GDP (as an indicator of economic growth) for 35 countries and 5 country groups. Majority of the countries and country groups depict positive and significant correlation coefficient between market capitalization ratio and growth, thereby establishing that both market capitalization ratio and growth move in the same direction in the short run. In order to test whether there exists a lead-lag relationship between market capitalization ratio and growth, I perform a Granger Causality exercise, a Variance Decomposition analysis and a panel VAR analysis. The results of the Granger Causality test suggest that for most countries and country groups, causality flows from stock market capitalization to growth and not the other way round. The Variance Decomposition analysis suggest that for majority of the countries and country groups, the percentage of fluctuations in per capita growth, as explained by a one time shock to market capitalization ratio is much greater than the fluctuations in market capitalization ratio which can be explained by a one-time shock to per capita growth, in periods following the realization of the shock. Finally, the panel VAR analysis indicates that for all countries and country groups, per capita growth is significantly influenced by past values of market capitalization ratio, although the reverse is not true. Thus the key stylized facts are (i) a contemporaneous positive and significant relationship between market capitalization ratio and growth and (ii) a lead-lag relationship between the two in the sense that the effect of a one-time shock to market capitalization gets translated to per capita growth to influence the latter's behaviour in future time periods.
In Chapter 2, I develop a Lucas asset pricing framework with production and investment, which can support only the lead-lag relationship but not the contemporaneous relationship between market capitalization ratio and growth. However, if a friction in the form of a borrowing constraint is introduced in this framework, it is able to reproduce both the contemporaneous and the lead-lag aspects of the market capitalization-growth relationship.
In Chapter 3, I first develop a model with imperfectly competitive market structure but fully flexible prices. This framework supports the contemporaneous positive relationship between market capitalization ratio and growth. But the correlation reproduced by this model is not quantitatively close to the observed correlations for most observed for most developed and developing countries. However, in the existing imperfect market structure, if nominal frictions in the form of price rigidity and imperfect inflation indexation are introduced, then the model is able to support the positive significant correlation between market capitalization ratio and growth for a wide range of values of the nominal rigidity parameters. But, in this model with nominal rigidities, which is essentially a New-Keyesian model with capital accumulation and endogenous growth, although a positive and significant market capitalization-growth correlation is re- produced for plausible nominal rigidity parameter values, this correlation starts falling gradually with increase in nominal rigidity and becomes negative for a very high degree of price rigidity. On the whole, it is established that the addition of frictions within different economic environments help in supporting the contemporaneous relationship between market capitalization ratio and growth.
|Item Type:||Thesis (Doctoral)|
|Award:||Doctor of Philosophy|
|Faculty and Department:||Faculty of Social Sciences and Health > Economics, Finance and Business, School of|
|Copyright:||Copyright of this thesis is held by the author|
|Deposited On:||31 Oct 2016 17:11|