Factors affecting the stock market development

There are some factors affecting the stock market development. Here will be provided the comparison of the determinants given in the different papers. The following papers will be reviewed and referenced here:

• “The Determinants of Stock Market Development in Emerging Economies: Is South Africa Different?” By Charles Amo Yartey

• “Macroeconomic Determinants of Stock Market Development” By Valeriano F. Garcia and Lin Liu*

• “The Determinants of Stock Market Development: The Case for the Nairobi Stock Exchange” by Josiah Aduba, Jacinta Mwelu Masila and Erick Nyakundi Onsongo

• “Stock Market Development and Economic Growth in Developing countries: Evidence from Panel VAR framework” by Boopen Seetanah, Rajit Sawkut, Vinesh Sannasee and Binesh Seetanah

• “Macroeconomic and institutional determinants of stock market development in MENA region: new results from a panel data analysis” by Monther Cherif and Kaothar Gazdar

Paper 1

According to Charles there are several factors which affect the stock market development the strongest. Charles believes that the key measurement of the stock market development is the market capitalization as a proportion of GDP.

• Income Level

Charles found that the real income is highly correlated with the size of the stock market. The higher income the better stock market develops. He applied the log GDP per capita in US Dollars to measure income level.

• Banking Sector Development

To determine the correlation between the banking sector development and the stock market development, Charles includes a measure of banking sector development in the regression. According to Charles most of the studies use M2 relative to GDP as a measure of financial depth. However, he stated that according to King and Levine (1993), this measure does not tell us whether the liabilities are those of the central bank, commercial banks or other depository institutions. The nature of the relationship between developments of stock market and banking sector is in the square of bank credit to the private sector as a percentage of GDP in the regression. The expectation is that the credit to the private sector is positively correlated with the capitalization of the stock market. However, very high levels of banking sector development can lead to substitutability between debt and equity making the coefficient of the square of bank credit negative.

• Savings and Investment

It is commonly known that the higher and larger the saving, the higher the amount of capital flows through the stock market. However Charles states that there is no high correlation between income and savings and investments. Thus it is expected that the savings and investments are the important determinants of development of the stock market.

• Stock Market Liquidity

The gap or the difference between the emerging and developed economies is highly correlated to the difference between the levels and liquidity of the stock market of the particular country. For instance US stock market and Russian stock market have a big difference between them. US stock market is highly liquid, people, institutions and companies are very active in trading of stocks, and whereas in Russia people and companies are too conservative to trade on stock market therefore it is less liquid. Also this gap can be explained by GDP which is high in US and lower in Russia. Charles explained that the liquid market eases the investments, therefore the capital flow into new and old businesses are getting higher.

• Macroeconomic Stability

It is true that the higher the macroeconomic stability, the more incentive firms and investors to participate in the stock market. Also the profitability of the private sector can be affected by changing the interest rate, the monetary, fiscal, and exchange rate policies. Garcia and Liu (1999) stated that determination of the impact of macroeconomic stability on market capitalization is done by using two measures: real interest rate and current inflation.

• Private Capital Flows

For the last few decades FDI (Foreign Direct Investments) has the important role in developing the emerging stock markets. Errunza (1982) stated that the impact of FDI on the development of the stock market is broader than the benefits from initial flows.

• Institutional quality

According to Charles investors who invest in foreign emerging stock markets face three risks, which are economic risk, financial risk and political risk. It is commonly known that countries with emerging economies are corrupted higher that the developed countries.