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stock companies had their beginnings in the mid 1930’s, when the first such company, the Arab Automobile Company was established. By 1975 there were 14 public companies. The rapid economic expansion and Saudisation of foreign banks in the 1970’s led to the establishment of a number of large corporations and joint venture banks. Major share offerings were made to the public during this period. The market remained informal, until the early 1980’s when the Government embarked on a rapid development program. In 1984, a Ministerial Committee consisting of Ministry of Finance and National Economy, Ministry of Commerce and Saudi Arabian Monetary Agency, SAMA, was formed to regulate and develop the market. With the aim of improving the regulatory framework, share-trading intermediation was restricted to commercial banks. In 1984, the Saudi Share Registration Company (SSRC) was established by the commercial banks. The company provides central registration facilities for joint stock companies and settles and clears all equity transactions. Automated clearing and settlement was introduced in 1989. The Electronic Securities Information System (ESIS), developed and operated by SAMA, was introduced in 1990. Tadawul, the new securities trading, clearing and settlements was launched in October 2001. And on 31/7/2003, The Capital Market Authority was established pursuant to the " Capital Market Law". The authority represents the government apparatus which is mainly entrusted with management and organization of the Saudi Capital Market, and
which reports directly to the chairman of the Council of Ministers. The authority is financially and administratively dependant, it is main objective is envisaged in organization and development of the capital market in the Kingdom, through enactment and enforcement of the rules and regulations for protection of investors and fairness and integrity of the capital market. The Stock Market index has grown from 690 points to more than 13000 points, a growth of more than 17000%, between 1985 to 2005Q2, and the number of transactions, volume and value traded increased dramatically. Goal of the Thesis The goal of the thesis is to empirically investigate the linkage between stock market development and economic growth using Saudi Arabia as a country case study. The study will intend to answer the following questions: 1. How can the development of the Saudi Stock Market be explained? 2. What factors are behind the Market’s recent high growth? 3. What is the nature of the relationship between stock market size, liquidity, and the economic performance? 4. What is the direction of this relationship? Is it going from stock market to economic growth or the other way around? Such questions are important to address because stock markets has been widely considered as an important tool for economic development, investment mobilization, and lowering firm’s cost of capital. In addition, understanding what account for stock market growth may help identifying the tools by which policy makers can motivate their activities.
Literature Review Economists have long held the belief that the financial structure of an economy is a crucial determinant of the level and rate of growth and its wealth. The economic relationship between financial development and economic growth has been extensively tested. There are three views explaining the relationship between financial development and economic growth. The first view suggests that financial development is a consequence of high growth that demands more and better financial development (Partick 1966). Robinson (1952) contended that financial development simply follows economic growth. The need for financial intermediation depends on the variance in growth rates among different sectors of the economy. Arestis, Demeriades and Luintel (2001) suggest that stock market development may actually hamper rather than help economic growth. The second view suggests that the supply of financial institutions and services stimulates investments in more productive resources. The financial development would then lead to economic growth. Shaw (1973) argued that a country’s financial sector does matter for economic development. Financial liberalization can more efficiently allocate savings by widening and diversifying the financial market within which investment opportunities compete for the savings flow. Mickinnon (1973) showed that the role of capital markets is crucial in the economic development process. The last decade has produced several important contributions (e.g., Bencivenga and Smith (1991), Atje and Jovanovic (1993), Gaytan and Ranciere (2003, 2004) etc.) in support of the view that financial structure is a crucial vehicle in the development process.
A third view is supported by group of economists who regards finance as a relatively unimportant factor in growth. Lucas (1988) declares that the finance growth relationship is "over-stressed". This view suggests that the finance and economic growth are causally independent. In addition to the previous three views, a fourth view can be formed supporting a two way relationship between financial sector development and economic growth. Greenwood and Smith (1997) argue that this sort of causality pattern seems likely over the long-run. Empirical literatures Goldsmith (1969) made the first finance-growth study that found a positive correlation between economic growth and the size of the financial system. Different correlation and causality patterns between finance and growth imply different policy implications. Kaufman and Jacoby (1986) showed that the declines in the stock market activities can explain much of the 1972-1978 slowdown of productivity in six industrialized OECD countries ( USA, Canada, Japan, UK, France and Germany). They also found that stock market declines often preceded a fall in productivity growth. Levine (1991) investigated how the stock market affects investment incentive and leads to change in the steady state growth rate. He identified two channels through which stock markets promote economic growth: diversifying portfolio and allowing investors to trade ownership of firms. In 1996, Mckinnon and Shaw developed basic models to affirm the positive role of financial intermediaries in the process of economic growth. They showed that financial development accelerates the rate of economic growth, therefore recommended liberalizing the financial system to spur economic growth. Rousseau and Wachtel (1998) found that the intensity of financial intermediation measures
Granger-cause real output, with little evidence of feedback from output intermediation. Darret (1999) examined the role of financial deepening in economic growth in three countries: Saudi Arabia, Turkey, and the United Arab Emirates. He concluded that a stationary relationship exist between real economic growth, the currency ratio, and the monetization variable. Allen and Gale (2000) stress that the competitive nature of markets encourages innovative, growth-enhancing activities. Rousseau and Wachtel (2000) show that both banking and stock market development explain subsequent growth. Stiglitiz (1985) and Bhide (1993), on the other hand, emphasis that stock markets will not produce the same improvement in resource allocation than banks. Stock Market Growth Literature Van Horne (1971) argued that the growth of stock markets around the world can be attributed to the increasing number of mutual funds and other investment institutions. Davidson (1978) presented a general description of how stock markets interact with economic activities. Kitchen (1986) indicated that a well-functioning stock market requires a substantial number of institutions that hold the savings of individuals. Sudweeks (1989) argued that stock market growth development requires the following a substantial positive economic growth rate and rational monetary policies. In addition, it requires a reasonable political stability and a favorable environment and legal framework. Calderon-Rossell (1990a) examined the structure and evolution of world stock markets. In Calderon-Rossell’s 1991 paper, a basic model of stock market growth was presented. Rossell presented a partial behavioral structural model of stock market growth that establishes a linkage between stock market and economic activities. Rossell suggested that stock market capitalization growth is determined by economic
growth, measured by GNP per capita, and additional stock market liquidity, determined by increase in the turnover ratio.
Empirical Methodology: The thesis will focus mainly on two issues: (1) Examining the relationship between Saudi stock market development and economic growth and what accounts for stock market growth and (2) Determining the direction of the relationship between the stock market and economic growth. In this thesis, the Calderon-Rossell’s partial behavioral structural model of stock market growth will be the foundation for estimating a regression equation that would empirically determine which factors stand behind the growth of the Saudi stock market from 1985Q1 to 2005Q4. Elements such as GDP growth, oil prices, and privatization policies will be included in the model to examine their relation to economic growth. To investigate the second issue, the thesis will examine data for the Saudi market between 1985Q1 and 2005Q4 to test if the causality is from stock market to economic performance or from economic performance to stock market- or does it work both ways? To answer these questions, the Johansen Cointegration Test and the Granger Causality Test techniques will be applied to investigate the empirical association between stock market and economic growth. Levine and Zervos (1996) recognized the importance of causality issue, and recommended that future research should examine the time series between stock market development and economic growth.
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