Relationship Between Stock Market Development and Economic Growth in Kenya

Abstract

This study aimed at finding the causal relationship between stock market development and economic growth in Kenya. The development of a stock market is determined by a number of factors that include market capitalization, liquidity, regulation and trades. This paper sought to investigate the causal relation between stock market capitalization, turnover and economic growth. Previous studies done on African stock markets characterize them to be small and hindered by various factors such as thin trading and illiquidity. These studies also point out that countries with well developed financial markets have a better level of per capita income than those with less developed markets. This notion is also confirmed by theory which states that there is a big role that financial markets (stock markets) play in boosting economic activity through provision of long-term capital for projects and risk diversification. There has not been a lot of work done on causal relationship between stock market development and economic growth in Kenya. Few studies show that traditionally the economy follows the stock market in terms of capitalization and there is some what lack of consensus on liquidity. The Kenyan stock market has made various strides in improving some of the aspects that are deemed to result in the development of the stock market and this has seen the increase in the number of listed firms on the bourse and also the improvement of regulatory laws that govern trading and disclosures. This study therefore aims to use the Granger test for causality on stock market capitalization to GDP ratio which represents the size of growth of the stock market, the stock market turnover ratio and GDP growth in Kenya over the period 1993-2012. The results show a strong positive relationship between stock market development and economic growth stemming from a one sided causal relation from market capitalization to economic growth while market liquidity (stock market turnover ratio) showed a non causal effect to economic growth. With the results found it is recommended that measures that boost the size of the stock market should be implemented so as to raise economic activity as the stock market in Kenya is seen to be forward looking and a proponent of long run economic growth.