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1 Business and Economics Journal, Volume 2010: BEJ-1
St ock M arket and Economic Gr ow t h: An Empirical Analysis f or Ger many
Adamopoulos Ant onios
Depar t ment o f Appl ied Info rmat i cs, Uni ver si t y o f M acedoni a, Th essaloni ki , M acedon ia, Gr eece

Cor r esp ondence t o: Adamopoul os Ant oni os, adamant @uo m.gr
Publ i shed onl i ne: Apr il 15, 2010
Abst r act
Th i s paper i nvest i gat es t he causal relat i onship bet w een st ock market devel opment and economic gr owt h f or Ger many f or t h e peri od
1965-2007 using a Vect or Er ro r Co rr ect io n M odel (VECM ). The pur pose of t h is paper w as t o examin e t h e long-run r el at i on sh i p
bet ween t hese var iabl es, app lyi ng t he Johansen co-in t egr at i on analysis based on t he cl assi cal uni t r oo t s t est s. The r esul t s of Gr anger
causal i t y t est s i nd icat ed t hat t here i s a uni di rect i onal causal it y bet ween st ock mar ket d evel opment and econo mi c gr owt h wi t h
di r ect i o n f rom st o ck mar ket d evel opment t o economi c gro wt h .
Keyw ords: St ock market ; Economi c gr ow t h ; VAR model ; Granger causal it y.

1. Int roduct ion
St ock mar ket development has b een t he sub j ect o f i nt en si ve t heor et ical and empi r i cal st udi es [ 1, 2] . M o r e r ecen t l y, t h e
emp hasi s has i ncr easi ngl y shi f t ed t o st ock mar ket i ndexes and t he ef f ect of st ock mar ket s on economi c developmen t .
St ock mar ket cont r ibut es t o t h e mob il i zat i on o f domest i c savings b y enhan cing t he set of f inan cial in st r umen t s avail abl e
t o saver s t o di ver sif y t hei r p or t f ol i os p rovi ding an i mpor t ant sour ce o f i nvest men t capi t al at r el at ivel y l ow cost . A w ell
f unct i oning and l iqui d st ock mar ket , t h at all ow s i nvest or s t o di ver sif y aw ay unsyst emat i c r i sk, w i l l i ncr ease t he margi nal
pr oduct i vi t y of cap it al [ 3] .
Anot her i mpo r t an t aspect t hr ough whi ch st ock market developmen t may in f luence economic gr ow t h i s r i sk
di ver si f i cat ion. Ob st f el d [ 4] suggest s t hat i nt er nat i onal r i sk shar ing t hr ough in t er nat ional l y i nt egr at ed st ock mar ket s
i mpr oves t he all ocat i on of r esour ces and accel er at es t h e pr ocess of economic gr ow t h .
Evol ut i on of st ock mar ket has impact on t he operat i on o f banki n g in st i t ut i ons and h en ce, on economic pr omo t i on . Th i s
means t hat st ock mar ket i s b ecomi ng mo re cru cial , esp eciall y i n a number of emer gin g mar ket s and t heir rol e should not
be i gnor ed [ 5] . Levi ne and Zer vos [ 2] argued t hat a w el l -est ab li shed st o ck mar ket n ot on l y can mobi l ize capi t al and
di ver si f y r i sks bet w een mar ket agent s but al so it is abl e t o p rovi de di f f er ent t yp es of f i nancial ser vi ces t han banking
sect or t o st i mu lat e economi c gro w t h .
Th e necessit y of st ock mar ket devel opmen t i s an i mper at i ve need in o r der t o achi eve fu l l ef f ici ency of cap it al al l ocat ion
i f go vernment can l i berali ze t h e f i nancial syst em. As f ar as physical accumul at i on i s concern ed , bo t h st ock market s an d
banks pro vi de sour ces of ext ernal f i nan cing f or f ir ms. For t he pu rpose o f r esour ce al l ocat i on, t hey bot h cr eat e
i nf or mat ion t o gui de t he al lo cat i on o f r esour ces. They di f f er onl y i n t he way t he in fo rmat i on is t r ansmi t t ed . Inf or mat ion
i n st ock mar ket s i s con t ained in equi t y p r i ces, w hi l e l oan manager s col lect t hat i n banks. Ther efo r e, whi l e banks f inance
on ly w el l-est abl i shed, saf e bor row er s, st ock mar ket s can f i nance r i sky, pr oduct i ve and innovat i ve i nvest ment pr oj ect s
[ 6] .
Fama and Sch wer t [ 7, 8] cl ai m t hat t her e ar e t h r ee exp lanat i on s fo r t h e st r ong l in k bet w een st ock pr ices and r eal
econ omi c act i vi t y: Fi r st , i nf or mat i on ab out fu t ur e r eal act i vi t y may be r ef l ect ed i n st ock pr i ces w ell bef or e i t occu r s -

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2 Research Article
t hi s i s essent iall y t he not io n t hat st ock pr ices ar e a leadi ng indi cat o r f or t he w ell -bein g of t he economy. Second , chan ges
i n di scoun t r at es may af fect st ock p r i ces an d real i n vest m ent si mil ar l y, but t he out put f r om r eal in vest ment does not
appear f or some t ime af t er i t i s made. Thi r d, changes in st ock p r i ces ar e changes i n weal t h , and t hi s can af f ect t h e
demand fo r consumpt i on and invest men t good s [ 8] .
Th e main obj ect ive of t hi s paper w as t o i nvest i gat e t he cau sal r elat i on sh ip among eco nomi c gr ow t h, st ock mar ket
developmen t and bank l en ding. St ock mar ket d evel opment and bank l endi ng favou r economi c gr ow t h.
Sect i on 2 descr ibes t h e sp ecif i cat i on of t h e model , devel op s t he Johansen co -i nt egrat i on analysi s, anal yses t he vect or
er r or cor r ect i on models and pr esen t s Gr anger causal it y t est s, w hi l e sect io n 3 pr esent s t h e empi r ical r esul t s. Fi nal l y,
sect i on 5 p ro vi des t h e concl u si ons of t hi s paper sin ce onl y a shor t d iscu ssion summar i zes in sect i on 4.

2. Dat a and specif icat ion model
2. 1. Dat a analysis:
In t h is st udy, t h e met hodol ogy of vect or aut or egr essive model (VAR) is app li ed t o est i mat e t he r elat ionshi p amon g
econ omi c gr ow t h, st ock mar ket developmen t and bank l en ding.
Suppose t hat a gener al vect or mod el can b e est i mat ed separ at el y, r egar di ng each var iabl e as a d ep end ent one w i t h
ot her t w o i ndependen t var iabl es r espect ivel y.
V = f (SM , GDP, BC) (2.1)
w here, SM i s t he general st ock mar ket i ndex; GDP i s t he gr oss do mest i c pr od uct ; BC is t he ban k lendin g exp r essed by
bank credi t s t o p r i vat e sect or .
Acco rd in g t o t he empi r i cal st udi es of King and Levine; Vazakid i s and Adamopoulos [ 9, 10, 11] , t he var iabl e o f economi c
gr ow t h (GDP) i s measur ed by t he r at e of change of r eal GDP, wh i le t he gen er al st o ck mar ket index is used as a pr oxy f or
t he st ock mar ket d evelopment . Th e gener al st ock mar ket i ndex (SM ) b et t er r epr esent s t he st ock exchan ge market t han
ot her f inancial in di ces [ 12, 13, 14, 15, 16, 17, 18] .
Th e sampl e used i n t hi s paper consist s of annual obser vat i on s f or Ger many and spans f ro m 1965 t o 2007 regar di ng 2000
as a base year . Al l t i me-ser i es dat a ar e expr essed i n t h ei r l evel s and ar e obt ai ned f r om Int er nat i onal Financi al St at ist i cs
[ 19] . The l i near mod el is sel ect ed as a bet t er model f or st at i st i cal est imat i on s t han a logar i t hmic o ne. Th e t est ed r esul t s
of t h e l ogar i t hmi c mod el have pr oved t o be st at i st i cal i nf er i or .
2. 2. Unit root t est s: For un ivar i at e t i me-ser i es, analysi s in vo lving st ochast ic t r ends, Augment ed Di ckey-Ful l er (ADF),
Ph il l i ps-Per r on (PP) and Kw iat kow ski et al (KPSS) [ 25] uni t r oo t t est s ar e cal cul at ed f or ind ividual ser i es t o pr ovide
evi dence as t o w het her t h e var iabl es ar e i nt egr at ed . Th is i s f o ll ow ed by a mul t i var iat e co -int egrat i on anal ysi s.
Augment ed Di ckey-Ful ler uni t r oo t t est s ar e calculat ed f or i nd ividual ser i es t o pr ovid e evidence as t o w het her t he
var iabl es ar e st at i onar y and i nt egrat ed of t he same o rder . Following the study of Seddighi et al [39] Augmen t ed
Di ckey-Ful l er (ADF) t est i nvol ves t he est i mat i on o f on e of t he fo ll ow i ng equat i ons r espect i vel y:
X
t
=

X
t-1
+

=

+ AX
p
j
t j t j
1
(2.2a)

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3 Business and Economics Journal, Volume 2010: BEJ-1
X
t
=
0
+

X
t-1
+

=

+ AX
p
j
t j t j
1
(2.2b)
X
t
=
0
+
1
t +

X
t-1
+

=

+ AX
p
j
t j t j
1
(2.2c)
Th e add i t i onal l agged t er ms ar e al so incl ud ed t o ensur e t hat t h e er ro r s ar e unco r r el at ed . Th e maxi mum l ag l en gt h
begi ns w it h 2 lags and pr oceed s down t o t he app ro pr iat e l ag by examin in g t h e AIC and SC i nf or mat ion cr i t er i a.
Th e nu ll hypot hesi s def i nes t hat t h e var iab le X
t
i s a non-st at i onar y ser i es (H
0
: =0) and i s r ej ect ed when i s si gni f i cant l y
negat i ve (Ha: <0). If t he cal cu lat ed ADF st at ist i c i s h igher t han M cKi nnon s cr i t i cal values, t hen t h e nu ll hypot hesi s (H
0
)
i s no t r ej ect ed and t he ser i es is non -st at i onar y or not i nt egrat ed of or der zer o I(0). Al t er nat i vely, r ej ect i on o f t he nu ll
hypo t hesi s i mpl i es st at io nar i t y. Fai lu r e t o r ej ect t he nu ll hypot hesi s l eads t o conduct i ng t he t est on t he d if f er ence of t h e
ser ies, so f ur t her d if f er enci ng i s conduct ed unt i l st at i onar it y i s r eached and t he nul l hypot hesi s i s r ej ect ed [ 20] .
In or der t o f i nd t he pr oper st r uct ur e of t he ADF equat i ons, i n t er ms of t h e in clusi on i n t h e equat i ons of an int er cep t (
0
)
and a t r end (t ) and i n t er ms of how many ext r a augment ed l agged t erms t o include i n t he ADF equat i ons, f or el imi n at ing
po ssib l e aut ocor r elat i o n in t he d i st ur bances, t he min imum val ues of Akai ke, Schwar z [ 21, 22] cr i t er io n (SC) based on t h e
usual Lagr an ge mul t ip li er LM (1) t est w er e employed . The Evi ew s economet r i c sof t war e package, whi ch i s used t o
conduct t h e ADF, PP, KPSS t est s, r epor t s t h e si mulat ed cr it i cal val ues based on r esponse sur faces.
Ph il l i ps and Per r on [ 23] t est is an ext ension of t he Dickey-Ful l er (DF) t est , w hi ch makes t h e semi-paramet r i c cor r ect ion
f or aut oco r r el at i on and is mo re r obust in t he case of w eak aut oco r r elat i on and het er oskedast ic r egr ession r esi dual s.
Acco rd in g t o Choi [ 24] , t he Ph i ll i ps-Per r on t est appear s t o b e mor e pow er fu l t han t he ADF t est f o r t he aggr egat e dat a.
Al t hough t he Phi ll i ps-Per r on (PP) t est gives d if f er ent lag pr of i les f or t he examin ed var i abl es (t i me-ser ies) and somet i mes
i n l ow er levels of si gni f ican ce, t he mai n concl usio n is qual it at i vel y t he same as r epo r t ed b y t he Di ckey-Ful l er (DF) t est .
Si nce t he nul l hypo t hesi s i n t he Au gment ed Di ckey-Ful l er t est i s t hat a t i me-ser ies cont ains a uni t r oo t , t h is h ypot hesi s i s
accept ed unl ess t h er e i s st r o ng evidence again st it . How ever , t hi s appr oach may be l ess ef f ect i ve again st st at io nary near
un it r o ot p rocesses. Kw i at ko w ski et al [ 25] p r esen t a t est w her e t he nul l hypo t hesi s st at es t hat t h e ser i es i s st at i onar y.
Th e KPSS t est co mpl ement s t he Augmen t ed Di ckey-Fuller t est i n t h at concer ns r egar di ng t he pow er of ei t h er t est can b e
addr essed b y co mpar ing t he si gni f i cance of st at i st i cs f r om bot h t est s. A st at i o nar y ser i es has si gni f ican t Augmen t ed
Di ckey-Ful l er st at i st i cs and i nsi gni f ican t KPSS
1
st at i st ics. The KPSS st at ist ic t est s f o r a r elat ive lag-t r uncat i on par amet er

1
Following the studies of Chang [37], Dritsakis and Adamopoulos [30], according to Kwiatkowski et al [25], the test of PSS assumes that a time-series can be
composed into three components, a deterministic time trend, a random walk and a stationary error:
yt = t + rt + t

where rt is a random walk rt = rt-1 + ut.. The ut is iid (0,
2
u
).

The stationarity hypothesis implies that
2
u
=0.
Under the null, yt, is stationary around a constant (=0) or trend-stationary ( = 0). In practice, one simply runs a regression of yt over a constant (in the case of level-
stationarity) ore a constant plus a time trend (in the case of trend-stationary). Using the residuals, ei , from this regression, one computes the LM statistic

=
T
t
t t
S S T LM
1
2 2 2
/


where
2
t
S

is the estimate of variance of t.

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4 Research Article
(l), i n acco rdance w i t h t he d ef aul t Bar t l et t ker n el est i mat ion met hod (since i t i s un kno wn ho w many l agged r esi duals
shou ld b e used t o con st r uct a con si st ent est imat o r of t h e r esi dual var i ance), r ej ect s t he nul l h ypo t h esis i n t he l evel s of
t he exami ned var iab les f or t he r elat i ve lag-t r uncat i on paramet er (l ). Theref o re t he combi ned r esu lt s (ADF, PP, KPSS)
f r o m all t est s can be char act er i zed as i n t egr at ed of or d er one, I (1). Th e r esul t s of t he Dickey-Fu ll er (DF), Augmen t ed
Di ckey-Ful l er (ADF), Ph il l i ps-Per r on (PP) and Kw i at kowski et al [ 25] (KPSS) t est s f o r each var iabl e appear i n Tabl e 1. If t h e
t ime-ser i es (var i ab les) ar e non -st at i onar y i n t h ei r l evel s, t hey can be i nt egrat ed w i t h i nt egrat i on o f or der 1, w hen t heir
f ir st di f f er en ces ar e st at i onar y, accor ding t o Dr i t sakis and Adamopoul os [ 30] .
2. 3. Johanse n co-int egrat ion t est : Since it has been det er mi ned, t hat t he var i abl es under exami nat i on ar e in t egr at ed of
or der 1, t he co -in t egr at ion t est i s per f or med. The t est i ng hypo t h esi s i s t h e nul l o f non -co-int egr at i on against t h e
al t er nat i ve t hat is t h e exi st ence o f co-i n t egr at ion usin g t h e Johan sen maxi mum l i kel i hood pr ocedu r e [ 26, 27] . Once a
un it r oot has b een con f i r med f or a dat a ser i es, t he quest i on i s wh et her t her e exi st s a long-r un equi l ib r i um r el at ionshi p
among var iabl es. Acco rd ing t o Engle and Gr anger [ 28] , a set of var iab l es, Y
t
is sai d t o be co -in t egr at ed of or der (d, b) -
denot ed CI(d , b) - i f Y
t
i s in t egr at ed o f or der d and t h er e exist s a vect or , , such t hat Y
t
is in t egr at ed of or der (d -b ). Co-
i nt egr at i on t est s in t hi s p aper ar e conduct ed usin g t he met hod developed by Johan sen and Ju sel i ou s [ 26, 29] .
Th e mul t ivar iat e co-int egr at i on t echni qu es d evel oped by Johansen and Jusel i ous; Engl e and Gr anger [26, 27, 28] usi ng a
maxi mum li kel ih ood est i mat i on pr ocedu r e al lo w s r esear ch er s t o est i mat e si mul t aneousl y mod el s i nvol vi ng t w o or mor e
var iabl es t o ci r cu mven t t he pr ob l ems associat ed w i t h t he t r adi t i onal r egr ession met hods used i n pr evio us st udi es on t h i s
i ssue. Ther ef or e, he Johansen met hod app li es t h e maxi mum l i kel i ho od pr ocedu re t o det er mi ne t he pr esence of co-
i nt egr at ed vect or s in non-st at i onar y t i me-ser ies.
Fo l lo w ing t he st udy of Chang and Caudi l l [ 38] , Johan sen and Ju sel i ou s [26, 29] pr opo se t wo t est st at i st ics f or t est in g t he
nu mber of co-i nt egr at ed vect or s (or t he r an k of ): t he t r ace (
t r ace
) and t he maxi mum ei genvalue (
max
) st at i st i cs. Th e
l ikel i hood rat i o st at i st i c (LR) f or t he t r ace t est (
t r ace
) as su ggest ed by [ 29] i s

trace
(r) = -T

+ =

p
r i
i
1
) 1 ln(

(2.3a)
w here =
i

i s t he l ar gest est i mat ed val ue of it h char act er i st i c r oot (eigenval ue) obt ai ned f r om t h e est i mat ed mat r i x, r
= 0, 1, 2,.p-1, and T is t he numb er o f usab le obser vat i on s.

=
=
t
i
i t
e S
1
, t = 1,2,T

The distribution of LM is non-standard: the test is an upper tail test and limiting values are provided by Kwiatkowski et al [25], via Monte Carlo simulation. To allow
weaker assumptions about the behaviour of t, one can rely, following Phillips [31] and Newey and Wests [32] estimate of the long-run variance of t which is defined
as:

= = + =


+ =
T
t
l
s
T
s t
k i i i
e e l s w T e T l S
1 1 1
1 2 1 2
) , ( 2 ) (
where w(s,l) = 1 - s / (l+1). In this case the test becomes

=
T
t
t
l S S T
1
2 2 2
) ( /

which is the one considered here. Obviously the value of the test will depend upon the choice of the lag truncation parameter, l. Here we use the sample
autocorrelation function of et to determine the maximum value of the lag length l.

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5 Business and Economics Journal, Volume 2010: BEJ-1
Th e
t r ace
st at i st i c t est s t he nu ll hypot hesi s t hat t he number of d ist inct charact er ist i c r oot s i s l ess t h an or equal t o r,
(w her e r i s 0, 1, or 2,) again st t he general al t er nat i ve. In t hi s st at i st i c,
t r ace
w i l l b e smal l w hen t he val ues o f t he
char act er i st i c r oot s ar e cl oser t o zero (and it s value w i l l be l ar ge in r elat io n t o t he values of t he char act er i st i c r oot s,
w hi ch ar e f ur t her f r o m zer o).
Al t er nat i vely, t he maxi mum ei gen value (
max
) st at i st i c as suggest ed b y Johansen i s

max
(r, r+1) = -T ln(1-
1 + r

) (2.3b)
Th e
max
st at ist ic t est s t h e nul l hypot hesi s t hat t he number o f r co-in t egr at ed vect or s i s r again st t he al t er nat ive of (r +1)
co -in t egr at ed vect or s. Thus, t he nul l hypot hesi s r =0 i s t est ed again st t he al t er nat ive t hat r =1, r =1 again st t he al t ernat i ve
r =2, and so f or t h . If t he est i mat ed val ue of t h e char act er i st i c r o ot i s cl ose t o zer o, t hen t he
max
w i ll be smal l .
It i s w el l known t hat Johan sen s co -i nt egrat i on t est s ar e ver y sen si t ive t o t he cho ice of lag l engt h . Fir st l y, a VAR model is
f it t ed t o t h e t i me-ser i es dat a i n or der t o f i nd an appropr iat e lag st ruct ur e. The Sch war z Cr i t er i on (SC) and t he l ikel i hood
r at io (LR) t est ar e used t o select t he number of lags r equi r ed i n t he co-int egr at i on t est . The Sch war z Cr i t er i on (SC) and
t he l i kel i hood rat i o (LR) t est suggest ed t hat t he value p =1 i s t he appr opr iat e sp ecif i cat i on f or t h e or der of VAR mod el f or
Ger many. Tabl e 2 pr esen t s t he r esul t s f r om t he Johansen and Jusel i ous [ 26, 29] co-i nt egr at i on t est .
2. 4. Vect or error correct ion model: Si nce t he var i ables incl ud ed in t he VAR mod el ar e found t o be co-in t egr at ed, t h e
next st ep is t o specif y and est i mat e a Vect or Er r or Cor r ect i on M o del (VECM ) incl ud in g t h e er r or cor r ect i on t er m t o
i nvest i gat e dynamic behavi our of t h e model. Once t h e equ il i br iu m condi t i on s ar e imposed, t h e VEC model descr ibes
ho w t h e exami ned model i s ad j ust i ng i n each p er iod t ow ar ds i t s l ong-run equ il i br i um st at e.
Si nce t he var iabl es ar e co-int egr at ed , so, i n t he sho r t r un , devi at i ons f r om t hi s l ong-r un equ il i br iu m w il l f eed back on t h e
chan ges in t he d ependent var iabl es in o rd er t o f o rce t h ei r movement s t owar ds t he l ong-run equ i li br i um st at e. Hence,
t he co -i nt egrat ed vect o r s f r om wh i ch t h e er r or cor r ect i on t er ms ar e der i ved ar e each indi cat i ng an indep end ent
di r ect i on wh er e a st abl e meaningf ul l ong-r un equi l i br i u m st at e exi st s.
Th e VEC speci f i cat io n fo r ces t he l ong-r un b ehavi ou r of t he endo genous var i abl es t o conver ge t o t hei r co-i nt egrat ed
r el at ionshi ps, w hich accommodat es shor t -run dynami cs. The dynamic speci f icat i on of t he model al l ow s t he del et i on of
t he i nsigni f icant var iab les, w hi l e t h e er ro r co r r ect i on t er m i s r et ai ned . Th e si ze of t he er r or cor r ect i on t er m i ndi cat es t h e
speed of adj ust ment o f any di sequi l ib r i um t oward s a long-r un equi l ib r i um st at e [ 28] . The er r or -cor r ect ion mod el w i t h
t he compu t ed t -values of t he r egression co ef f i cient s i n par en t heses i s r epor t ed in Tab le 3.
Th e f i nal f or m of t he Er r or -Cor r ect ion M odel (ECM ) w as sel ect ed acco rd ing t o t he appr oach suggest ed by Hend r y [ 33] .
Th e gener al f orm o f t he vect or er r or co r r ect i on model (VECM ) i s t h e f ol lo w ing on e:
t i t i t
n
i
n
i
n
i
i t i t t
EC Z + + A + AY + AX + = AX


3 2 1 0
(2.4)

w here is t he f i r st d if f er ence op er at or , EC
t -1
is t h e

er r o r co r r ect i on t er m lagged one per iod , i s t he shor t -r un coef f ici ent
of t h e er ro r co r r ect i on t er m (-1<<0),
t
i s t h e w hi t e no ise t er m.
2. 5. Granger causalit y t est s: Gr anger causal i t y i s used f or t est i ng t he l ong-r un r elat i onshi p bet w een st ock mar ket
developmen t and economi c gro w t h . Th e Granger pr ocedu r e i s sel ect ed because i t con si st s t he mor e pow er f u l and
simp ler way of t est in g causal r el at i onship [ 34] . The f ol l ow i ng bi var iat e mod el is est i mat ed :

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6 Research Article
t
k
j
j t j j t
k
j
j t
u X b Y a a Y + + + =

=

= 1
1
1
1 10
(2.5a)
t
k
j
j t j j t
k
j
j t
u Y b X a a X + + + =

=

= 1
2
1
2 20
(2.5b)
w here Y
t
i s t he dependent and X
t
i s t h e expl anat o r y var iabl e and u
t
is a zer o mean whi t e noi se er ro r t er m i n Eq (2.5a),
w hi l e X
t
i s t h e dependent and Y
t
i s t h e explanat or y var iab le in Eq (2.5b).
In or der t o t est t he above hypo t heses t he usual Wald F-st at ist i c t est i s ut i li sed, w hi ch has t h e fo ll ow ing f o rm
) 1 2 /(
/ ) (

=
q T RSS
q RSS RSS
F
U
U R

w here
RSS
U
= i s t h e su m of squar ed r esidual s f r o m t he comp l et e (u nr est r ict ed) equat ion
RSS
R
= t he su m o f squar ed r esi dual s f ro m t he equat i on und er t he assumpt i on t hat a set of var i abl es i s r edundan t , when
t he r est r ict io ns ar e i mpo sed, (r est r ict ed equat i on )
T = t he samp le si ze and q = i s t he lag l engt h .
Th e hypot heses in t h is t est ar e t he f o ll ow in g:
H
0
: X d oes not Gr anger cau se Y, i .e. {
11
,
12
,...
1k
}=0, i f F
c
< cr it i cal val ue of F
.
H
a
: X d oes Gr anger cau se Y, i .e. {
11
,
12
,.
1k
}0, if F
c
> cr it i cal value of F. (2.6a)
and
H
0
: Y d oes not Gr anger cau se X, i .e. {
21
,
22
,...
2k
}=0, i f F
c
< cr i t ical value of F.
H
a
: Y d oes Gr anger cau se X, i .e. {
21
,
22
,.
2k
}0, if F
c
> cr i t i cal val ue o f F. (2.6b)
[ 35] .
Th e r esul t s r elat ed t o t he exi st ence o f Granger cau sal r elat i on sh ip s amon g economic gr ow t h, st ock mar ket
developmen t , and ban k l end i ng ar e pr esen t ed i n Tab l e 4.
3. Empirical re sult s
Th e ob ser ved t -st at i st i cs in t he t ab le 1 f ai l t o r ej ect t he nu ll hypot hesi s o f t h e pr esence of a uni t r oo t f or all var iab les i n
t hei r l evel s conf i r mi ng t hat t hey ar e non -st at i onar y at 1% and 5% levels of signi f icance. Th e comb i ned r esul t s (ADF, PP,
KPSS) f rom all t est s show t hat t he nul l h ypo t h esis of t he pr esen ce o f a un it r oot i s r ej ect ed f or al l var iabl es w hen t hey
ar e t ransfo r med in t o t heir f i r st d if f er ences (Tabl e 1). Ther efo r e, al l ser i es t hat are used ar e non -st at i onar y i n t h ei r l evel s,
bu t st at i onar y in t hei r f i r st di f f er ences (in t egr at ed of or der one I(1). Ther efo r e, fo l lo w in g Dr it saki s and Adamopoul os

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7 Business and Economics Journal, Volume 2010: BEJ-1
[ 30] t h ese var iab les can be co-in t egr at ed as w el l , i f t her e ar e one or mor e li n ear comb inat i ons amon g t h e var iab les t hat
ar e st at i onar y.
Th e r esu lt s t hat appear i n Tabl e 2 su ggest t hat t he number o f st at i st i cal l y signi f i cant co-i nt egrat i on vect o r s f or Ger man y
i s eq ual t o 1. The p rocess of est i mat i ng t he r an k r i s r el at ed w i t h t he assessm ent of eigenval ues, whi ch ar e t h e fo ll ow in g
f or Ger many: =
1

0.3755, =
2

0.1689, and =
3

0.0464. For Germany, cr i t i cal val ues f or t he t r ace st at ist i c d ef ined b y

equat i on (2.3a) ar e 24.27 f or : r = 0, 9.53 f or : r s1, and 1.95 f or : r s2 at t h e si gn if i cance level 5% r espect ivel y as
r epo r t ed b y Ost er wal d -Lenu m [ 36] , whi l e cr i t i cal val ues f or t he maximum ei genvalu e t est st at ist i c d ef in ed by equat ion
(2.3b) ar e 19.30 fo r : r = 0, 7.58 f or : r s1, 1.95 fo r : r s2 (Tabl e 2).
It i s ob vi ou s f r om t he above co -i nt egrat ed vect or t hat econ omi c gr ow t h and bank l ending have a posi t i ve ef f ect on st ock
mar ket developmen t i n t he l ong run. Accor ding t o t he si gns o f t he vect or co-in t egr at ion co mpon ent s and based on
econ omi c t heor y, t h e above r elat i on shi ps can be used as an er r or cor rect ion mechan ism in a VAR mod el f or Ger many
r espect i vel y. The best VAR model in w hi ch economi c gr ow t h i s examined as a dependent one i s sel ect ed by t h e t h ree
VAR model s t h at can b e est i mat ed r espect i vely.
Th e r esu lt s of t h e est i mat ed vect o r er ro r co r r ect i on model suggest t hat a sho r t -run incr ease of st ock mar ket i ndex per
1% i nduces an i ncr ease of economic gr ow t h p er 0.06% i n Ger man y and an i ncr ease of bank l ending p er 1% i nduces an
i ncr ease of economi c gr ow t h per 0.9% i n Ger many. The est i mat ed coeff i ci en t of EC
t -1
i s st at i st i call y signi f icant and has a
negat i ve si gn, whi ch con f i r ms t hat t her e i s no p rob l em in t he l ong-r un equ il i br i um r elat i on b et w een t he i nd ep end ent
and dependen t var i ab l es i n 5% l evel of si gn if i cance, but i t s r el at i vely val ue (-0.017) f or Ger many show s a sat i sf act or y
r at e of conver gence t o t he equi l ib r i um st at e p er per iod (Tabl e 3). In o rd er t o pr oceed t o t he Gr an ger causal it y t est t h e
nu mber of app r op r iat e t i me lags was sel ect ed in accor dance w i t h t h e VAR mo del. Accor di ng t o t he r esu l t s o f Tabl e 4, it
can be i nf er r ed t hat indi cat ed t hat t her e i s a uni di r ect i onal causal i t y b et w een st ock mar ket developmen t and economi c
gr ow t h w i t h di r ect i on f r om st ock mar ket devel opment t o economi c gro w t h .
4. Discussion
Th i s model o f f i nancial syst em in vest igat es t he cau sal r el at ionshi p amon g economi c gr ow t h, st ock mar ket devel op ment
and bank l endi ng. St ock mar ket developmen t i s det ermi ned by t he t r end o f general st ock mar ket i ndex. The si gn i f i cance
of t he emp ir i cal r esu lt s i s d ependent on t h e var i ab l es under est i mat i on . M ost empi r i cal st udi es examin e t h e r el at ionshi p
bet w een econo mi c gro w t h and f i nancial mar ket developmen t usin g d if f er ent est imat i on measur es. The most
r epr esen t at i ve est i mat ion measur es fo r f inanci al market devel op ment ar e t h e gener al st ock mar ket i ndex, st ock mar ket
l iq ui di t y and bank cr ed i t s t o pr i vat e sect o r . The general st ock mar ket index expr esses t h e t r end o f st ock mar ket
developmen t i n conj unct i on w it h t he i nvest men t gr ow t h and t he l ow in t er est r at e. Theor y pr ovid es conf l i ct in g aspect s
f or t he i mpact of st ock mar ket developmen t on economi c gr ow t h o r vi ce-ver sa. Ver y f ew empi r ical st udi es have
concent r at ed on examin ing t he causal r elat i on sh ip bet w een economic gr ow t h and st ock mar ket devel op ment and ban k
l endi ng. The r esul t s o f man y empi r ical st udi es examin ing t h e r elat i onsh ip bet w een st ock mar ket develo pment and
econ omi c gro w t h di f f er , r el at i vel y t o t he sampl e per iod, t he examined count r i es, t he measur es of f inan cial
developmen t , and t h e est i mat i on met hod. The r esul t s of t hi s paper ar e agr eeabl e w i t h t he st udi es of Levine and Zer vo s;
Ki ng and Levin e [2, 9] . The d ir ect i on of causal r elat i onsh i p bet w een st ock mar ket develo pmen t and econo mi c gr ow t h is
r egard ed as an impor t ant i ssue under consid erat i on i n f ut ur e empi r i cal st u di es. Ho w ever , mor e i n t erest shou ld b e
f ocu sed on t he compar at ive anal ysis of empi r i cal r esult s f or t he r est of Eu rop ean Uni on member -st at es.
5. Conclusion
Th i s paper exami nes empi r ical l y t he r el at ionshi p bet w een st ock mar ket developmen t and economic gr ow t h f or
Ger many, usi ng annual dat a f or t he per iod 1965-2007. Th e empi r ical anal ysi s su ggest ed t hat t he var iabl es t hat

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8 Research Article
det er mine economi c gro w t h pr esent a uni t r oo t . Once a co -i nt egrat ed r elat ionshi p among r el evant economic var iabl es i s
est abl i sh ed, t he next i ssue i s how t hese var i ab l es adj ust in r esponse t o a r andom shock. Thi s i s an i ssue of t h e shor t -run
di sequ il i br i um d ynami cs. Th e sho r t r un dynamics of t he model is st udi ed by anal ysing how each var iab le i n a co-
i nt egr at ed syst em r espond s or cor r ect s i t sel f t o t he r esid ual or er r or f r om t h e co in t egr at in g vect or . Thi s j ust i f i es t h e use
of t he t er m er r or cor r ect i on mechani sm. The er r or corr ect ion (EC) t er m, pi cks up t he speed of ad j ust men t of each
var iabl e i n r espon se t o a deviat i on f r om t h e st eady st at e equ il i br i um. Th e VEC specif i cat i on f or ces t he l ong-ru n
behaviour o f t he endogeno us var iabl es t o con ver ge t o t h ei r co -int egrat i n g r elat i onship s, wh ich acco mmodat es t h e
shor t -r un dynami cs. The dynami c speci f icat i on of t he model su ggest s del et io n of t he i nsigni f i cant var iab les w hi l e t h e
er r or cor r ect io n t er m i s r et ai ned . The r esu lt s of Gr anger cau sali t y t est s i ndi cat ed t hat t her e is a uni di r ect i onal cau sali t y
bet w een st ock market devel opment and economi c grow t h w i t h di r ect ion f r om st ock mar ket d evelopment t o economi c
gr ow t h.

Compet ing I nt erest s
Th e au t hor declar es t hat he has no comp et ing i nt er est s.
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Table 1 -Tests of Unit Roots Hypothesis.
Augmented Dickey-Fuller Phillips-Perron KPSS

ADF_test
stat

Lag
eq_f

PP_ test stat

LM test stat
tn tc tt hc ht
GERMANY
SM -2.91
[0.16]
p=1
(2.2c)
1.09
(for k=3)
-0.02
(for k=3)
-2.30
(for k=2)
0.75
(for k=5)
0.17***
(for k=3)
BC -0.97
[0.93]
p=1
(2.2c)
1.67
(k=4)
-1.76
(k=4)
-1.36
(k=4)
0.77
(l=5)
0.29
(l=0)
GDP -2.46
[0.34]
p=1
(2.2c)
3.69
(for k=4)
0.74
(for k=4)
-2.32
(for k=4)
0.80
(for k=5)
0.14***
(for k=5)
SM -3.78
[0.00]
p=0
(2.2a)
-3.79
(for k=3)
-3.85
(for k=4)
-3.73
(for k=5)
0.15
(for k=2)
0.03
(for k=3)
BC -4.60
[0.00]
p=1
(2.2c)
-5.61
(k=0)
-6.09
(k=4)
-6.39
(k=4)
0.23
(l=4)
0.07
(l=4)
GDP -3.04
[0.03]
p=0
(2.2b)
-1.16*,**,***
(for k=3)
-3.05***
(for k=1)
-3.15*,**,****
(for k=1)
0.24
(for k=4)
0.12*
(for k=4)
Notes:
The calculated statistics are those reported in Dickey-Fuller (1981).The critical values for SM and GDP at 1%, 5% and 10% are -4.19, -3.62, -3.19, for BC, BC at 1%, 5% and 10% are -
4.19, -3.52, -3.19, for SM at 1%, 5% and 10% are -2.62, -1.94, -1.61, for GDP at 1%, 5% and 10% -3.60*, - 2.93, -2.60 respectively.
The lag-length (p) structure of a of the dependent variable xt is determined using the recursive procedure in the light of a Langrange multiplier (LM) autocorrelation test (for orders up to
two), which is asymptotically distributed as chi-squared distribution and the value t- statistic of the coefficient associated with the last lag in the estimated autoregression.
The critical values for the Phillips-Perron unit root tests are obtained from Dickey-Fuller.
tn, tc and tt are the PP statistics for testing the null hypothesis the series are not I(0) when the residuals are computed from a regression equation without an intercept and time trend, with
only an intercept, and with both intercept and time trend, respectively. The critical values at 1%, 5% and 10% are -2.62, -1.94, -1.61, for tn, -3.60, -2.93, -2.60 for tt, and for -4.19, -3.52, -
3.19 for t respectively.
k= bandwidth length: Newey-West using Bartlett kernel.
hc and ht are the KPSS statistics for testing the null hypothesis that the series are I(0) when the residuals are computed from a regression equation with only an intercept and intercept and
time trend, respectively. The critical values at 1%, 5% and 10% are 0.73, 0.46 and 0.34 for hc and 0.21, 0.14 and 0.11 for ht respectively [25].
Since the value of the test will depend upon the choice of the lag truncation parameter, l.
l= bandwidth length: Newey-West using Bartlett kernel.
***, **, * indicate that those values are not consistent with relative hypotheses at the 1%, 5% and 10% levels of significance relatively.



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11 Business and Economics Journal, Volume 2010: BEJ-1
Table 2 Johansen and Juselious Co-integration Tests (SM, GDP, BC).

Country

GERMANY


Testing
Hypothesis

Johansen Test Statistics
trace Critical value
5%
[prob]**
max Critical value
5%
[prob]**

H0: r = 0 and r=1 (None *)

28.8418


24.2759
[0.0124]

19.3052

17.7973
[0.0295]
H0: r s 1 and r=2 (At most 1) 9.5366 12.3209
[0.1401]
7.5855 11.2248

H0: r s 2 and r=3 (At most 2)

1.9511

4.1299
[0.1913]

1.9511

4.1299
[0.1913]

Co-integrated vectors

1

1
Notes
Tr ace t est and M ax-eigenval ue indicat e 1 coi nt egr at in g eqn(s) at t he 0.05 level
* denot es r ej ect io n of t he hypot hesis at t h e 0. 05 level
* * M acKi nnon-Haug-M ichelis (1999) p-valu es



Table 3 - Vector Error Correction Model (SM, GDP, BC).
Vector Error Correction Estimates
Sample (adjusted): 1967 2007
Included observations: 41 after adjustments
Standard errors in ( ) & t-statistics in [ ]


Cointegrating Eq: CointEq1


SMGER(-1) 1.000000

GDPGER(-1) -0.605894
(0.10138)
[-5.97634]

BCGER(-1) -0.178611
(0.10298)
[-1.73445]


Error Correction: D(SMGER) D(GDPGER) D(BCGER)


CointEq1 -0.440602 -0.017862 -0.044208
[-4.47936] [-0.75031] [-1.02758]

D(SMGER(-1)) 0.555201 0.068946 0.012370
[ 4.02611] [ 2.06577] [ 0.20509]

D(GDPGER(-1)) -1.539101 0.775564 0.138604
[-3.08760] [ 6.42846] [ 0.63574]

D(BCGER(-1)) -0.324338 0.090790 0.067019

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[-0.84622] [ 0.97872] [ 0.39979]


R
2
0.421772 0.390310 0.016623
Adj. R
2
0.374888 0.340875 -0.063110
Sum sq. resids 0.174382 0.010215 0.033358
S.E. equation 0.068651 0.016616 0.030026
F-statistic 8.996185 7.895510 0.208482
Akaike AIC -2.427081 -5.264490 -4.081026
Schwarz SC -2.259903 -5.097312 -3.913849


VEC Residual Serial Correlation LM Tests 3.6585 [0.9324]
VEC Residual Normality Tests Jarque-Bera 1.1168 [0.5721]
[ ]= I denote the t-statistics
: Denotes the first differences of the variables.
Adj. R
2
= Coefficient of multiple determinations adjusted for the degrees of freedom (d.f),





Table 4 Pairwise Granger Causality Tests.

Sample: 1965 2007
Lags: 3

Null Hypothesis:
Obs Wald F-Statistic Probability

GDP does not Granger Cause SM

42

5.6885

0.0220

SM does not Granger Cause GDP

0.3489

0.5581

BC does not Granger Cause SM

42

2.1726

0.1485

SM does not Granger Cause BC

0.3489

0.5648

BC does not Granger Cause GDP

42

0.1176

0.7335

GDP does not Granger Cause BC

1.5324

0.2231