Abstract:
Capital markets long played an important role in economic development. Recently,
attention was grabbed by the stock market performance and economic growth. The
objective of this study was to explore the causal relationship between stock market
performance and economic growth. The study used time-series data throughout 1990 -
2018. Data were collected from the Colombo Stock Exchange, World Bank data, and
Central Bank annual reports. Market capitalization was used as the proxy for stock market
performance and Gross Domestic Production (GDP) was used as the proxy for economic
growth. The macroeconomic variables such as export, Foreign Direct Investment (FDI),
inflation, and capital formation were used as the control variables in this study. According
to the Augmented Dickey Fullar (ADF) test, the data set was stationary at the first
difference form. Johanson co-integration test, Vector Error Correction Model, and
Impulse Response Functions were used to check the short-run dynamics and long-run
relationship between the stock market performance and economic growth. The cointegration test results confirmed that there is a long-run relationship between stock
market performance and economic growth. The Impulse Response Function suggested
that shocks from the stock market did not make an immediate effect on economic growth
but in the long run there existed a positive relationship. Other macroeconomic variables
showed fluctuated negative impacts on economic growth while Foreign Direct Investment
managed to create a positive relationship in the long run. Therefore, the study
recommends the policymakers to increase the concern towards the stock market
performance to boost economic growth.
Keywords: Economic growth, long-run relationship, Macroeconomic variables, Market
capitalization, Stock market performance
