Factors on Stock Market Development in SAARC Region

The Impact of Institutional and Macroeconomic Factors on Stock Market Development in SAARC region

• Fayaz Ahmed Soomro

Problem Statement

There are many researches concerned about the relationship between the Macroeconomic variables and the stock market performances[1]. Researchers have analyzed many different factors of Macroeconomic variables like GDP, Savings, Credit facilities, Shares traded, interest rates, remittances from abroad, trade deficit, consumer banking, production of industrial goods, liquidity and more macroeconomic factors having significant impact and are the major contributors in stock market development[2]. Researches also claim that there is one way relationship between stock market development and macroeconomic variables[3]. Researchers have also concentrated on the impact of quality of institutions on the development of equity market in developing countries specially[4]. However there is has been not much interested directed towards institutional quality having impact on stock market development in SAARC region. This research is focused on testing the theory and adding empirical evidence from in terms of impact of quality of institutions on the development of equity market. This research might help the respective countries of SAARC in understanding better the factors contributing in the development of stock market in the SAARC territory and May helps the policy makers to devise better and effective policies for the whole region.

Objective

To determine the impact of the quality of institutions with macroeconomic factors are having on the development of stock markets in SAARC region.

Research Question

What is the impact of quality of institutions with macroeconomic factors on the performance of the stock markets?

Literature Review

Development of the Stock markets and the growth of the economy

There has been found that stock market development and economic prosperity are highly correlated Levine and Zervos (1996). The study adopted positivist approach and correlational in nature and based on 41 countries in the period 1976- 1993, the quantitative method was adopted. It was deduced based on the hypothesis taking sample population of 41 countries in the period 1976- 1993 that there exist a high correlation among stock market and growth of economy.

Get Help With Your Essay

If you need assistance with writing your essay, our professional essay writing service is here to help!

Essay Writing Service

Unidirectional effect of Macroeconomic Variables

Macroeconomic factors affects the stock prices in the unidirectional way that is stock prices does not affects the Macroeconomic variables to change Hussain and Mehmood (2001). The approach adopted is quantitative in nature and falls in the domain of positivist research paradigm. The deduction was based on sample population of Pakistan by considering the period of 1959-60 to 1998-99.

Stock Market and Economic Prosperity Evidence from India

Economic prosperity is highly related with the stock market performance in the economy Deb and Mukherjee (2008). He analysed by the quantitative research methods and hence within positivism research paradigm that in India economic prosperity leads to the better stock market performances. He deduced that there is a relationship between economic prosperity and the stock market development in India by taking sample population of India from the period of ten years. It was also found that there exists a bidirectional causal relation among the said variables.

Development in the Stock Market of Pakistan

Liquidity and the prices of the stocks do not have any relation in any direction Ali et al. (2010). This research falls into the Post Positivism research paradigm because it is refuting the generalization made in the literature that money supply and stocks prices have no relation at all in any direction. This was tested by using Granger-causality test, Augmented Dickey Fuller, Unit Root Test and the test of co-integration (Johansen) have been applied. He also found that there is no causality effect among the liquidity and stock prices, industrial production , exchange proportion, rising prices, balance of trade and prices of the shares in Pakistan.

Foreign Direct Investment is highly related to stock market development Raza et al. (2012) this research adopted quantitative and hence followed the positivism research paradigm that is, it tested the theory in consistent with the literature. The factors like savings, rising prices and money exchange rates were also considered and were found significant. Savings were in line with stock market however inflation and money exchange rate were found to have a negative impact.

The research found that 70 percent of the increase in development of stock market is caused by the one percent change in FDI inflow. This is a huge impact so the government of Pakistan should be looking forward to protect the foreign investors and facilitate them as much as possible. There should be framework under which the foreign investors can take the easily their part and keep on investing in order to promote the stock market activities in the region.

Stock Market development in Bangladesh

The stock market of the Bangladesh is not mature yet and it’s not up to the standards of international markets, however this research identified many factors affecting the stock market development in Bangladesh Rrahman and Rahaman (2011). The research adopted quantitative and followed Positivist approach. Data was collected from the period 2001 to 2008 and was collected from various reliable sources of Bangladesh. Many different statistical techniques were used like descriptive analyses, correlation analyses were applied. All the variables were found to have significant impact. It was also suggested that Bangladesh stock market is highly volatile and there has much to improve in order to make it up to international standards.

Stock Markets and the Institutional Quality

Insitutional quality plays important role in the development of various sectors of the economy. Its implication has been tested and proved significant in the non banking financial sector in the Middle East and African regions Creane et al. (2004). The proxies that were used are Banking Industry, Money Supply, yearly monetary and fiscal policies, industrial regulations, financial corruption and the quality of institutions. Recommendation made in this report is about to increase the quality of institutions.

Yartey (2008) Institutional factors including the political stablity, quality in bureaucracy, stability of democracy, corruptions, general regulations and laws with other macro economic factors were found to have a significant effect on the stock market activities because it usually increases financial facility to the general public and they tend to invest in the equity market. The data was collected from the period 1990 until 2004 that is total 14 years of 42 emerging economies. The data was analyzed through regression analysis. However risk in the political stability was suggested a major contributing in the stock exchange market enhancement.

In other Burhop et al. (2011) tried to find the regulatory body as the important components of the stock exchange market. In his studies he considered London equity market and the stock market of berlin and quantified as in the form of IPO- initial Public Offerings. However he could not conclude whether regulatory body plays an important role in the stock market activities but he found that long term profits and survival in the competition as the important factor in the successful market.

Research Methodology

Epistemology

This research tries to identify the Institutional factors and other macroeconomic factors that lead to the development of stock market, this knowledge already exist and justified in the region of Middle East in the International Monetary Fund’s working paper of Billmeier and Massa (2007).

Nature of Knowledge

This research tries to test already existing knowledge in the literature Billmeier and Massa (2007) which was specifically applied in the regions of Middle East and Central Asia. The theory has been tested quantitatively that exist in literature and adopted Positivism approach. This research adds the empirical proof from the SAARC region.

Methodology- Positivism

This research is also quantitative in nature and follows the positivism approach because it’s in consistent with the existing literature and follows the systematic scientific approach to find its applicability in the SAARC region. The gap in the empirical evidence was identified and in order to fill the gap same propositions were developed but in different context of its application

Validity

The method, approach, statistical technique and the measurement of the variables are in consistent with the International Monetary Fund’s working paper. That means theory already exist but it has been applied in the different context that is in SAARC region. Institutional quality has been measured as a index of Economic freedom by Heritage Index of Economic Freedom and other macroeconomic variables has been measured and reported by the World Bank and the data has been collected from their published reports. The detailed measurement is as follows

Market Capitalization: This is has been measured as total value of the shares outstanding in the stock markets which is the total sum of shares prices multiplied by the no of outstanding securities. For this research it has been taken as the percentage of GDP.

IQ: Institutional Quality: Institutions are the formal governing bodies in any country which look after the overall governing structure of the economy. These institutions guide the economy about political activities, social activities and the economic activities. Quality of institutions is enhanced with efficient and effective working of institutions. Quality is measured by Heritage Foundation as score from 0 to 100, the lowest value being the poorest form of quality and higher the score the higher the quality.

INC: Income: It is represented as the total value of production within the country and has been measured at constant base of year 2000 US $ in Billions.

INV: Investment: It is represented by the addition in the aggregate value of fixed assets with any inventories. This has been taken in this research as capital formation percentage of the GDP

SVT: Stock value traded: It is represented by the shares total value in the specific period. This has been also taken as percentage traded over GDP

DC: Domestic credit: It is represented by the total value of lending to the customers in the private sectors. This has also been taken as percentage of GDP.

Reliability

This theory has been applied in the region of SAARC region from the period 1996 to 2012. It is suggested the this theory will produce more or less the same results if carried out in the different period of time in the SAARC region

Generalizability

This same theory was applied and proved in the region of Middle East. This research also proved and produced the same results in the SAARC region hence It can be concluded that this theory is applicable to the regions with similar conditions of economy like in Middle East and Central Asia.

Synthetic a posteriori proposition

The proposition in this research says that Institutional Quality and macroeconomic factors have significant and positive impact on the stock market development in the SAARC region. This proposition is a synthetic a posteriori and subject to empirical verification from the above region.

Deduction Reasoning

General statements

1: Quality of institutions affects significantly on the development of stock market.

2: GDP affects significantly on the development of stock market.

3: Domestic credit affects significantly on the development of stock market.

4: Stock traded value affects significantly on the development of stock market.

5: Gross capital formation affects significantly on the development of stock market.

Hypotheses

Ho1: Quality of the institutions affects insignificantly on the development of stock market.

Ha1: Quality of the institutions affects significantly on the development of stock market.

Ho2: GDP affects significantly on the development of stock market.

Ha2: GDP affects insignificantly on the development of stock market.

Ho3: Domestic credit affects significantly on the development of stock market.

Ha3: Domestic credit affects significantly on the development of stock market.

Ho4: Stock traded value affects significantly on the development of stock market.

Ha4: Stock traded value affects significantly on the development of stock market.

Ho4: Gross capital formation affects significantly on the development of stock market.

Ha4: Gross capital formation affects significantly on the development of stock market.

Conclusion

1: Institutional quality does impact significantly on the development of stock market

2: GDP does impact significantly on the development of stock market

3: Domestic credit does impact significantly on the development of stock market

4: Stock traded value does impact significantly on the development of stock market

5: Gross capital formation does impact significantly on the development of stock market

Falsification

As this research is in consistent with the existing theory and has been only tested without amendments hence it is not refuting any theory of knowledge but adds empirical evidence in the literature from untested region that is South Asian Association of Regional Cooperation (SAARC) countries.

Data Collection and Source

In this research secondary data has been used. Data of institutional quality collected from the Index of Economic Freedom of Heritage Foundation. Data of macroeconomic variables collected from the World Bank.

Target Population

The research focuses on the regions of SAARC economies in particular countries Pakistan, Bangladesh, India, Nepal and Srilanka.

Sample Size

The dataset of 5 economies has been considered. The year 1995 to 2010 that is for 15 years of 5 countries of the SAARC region making it a total observations of 75 has been taken as the sample size.

Statistical Technique

The sample data of dependent variable and independent variables will be analyzed by ordinary least square method of multiple regression analyses technique.

Research Model

MCP = α + β1 IQ + β2 INC + β3 INV + β4 SVT + β5 DC + e

Where

MCP:Market Capitalization

IQ: Institutional Quality

INC: Income

INV: Investment

SVT: Stock value traded

DC: Domestic credit

1

[1] Deb and Mukherjee (2008) Mustafa and Cagatay (2012)

[2] Ali et al (2010), Raza et al (2012)

[3] Hussain and Mehmood (2001)

[4] Billmeier and Massa (2007), Lombardo and Pagano (2000), Yartey (2008), Burhop et al (2011)