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ermore, other economists make a stronger case against the development of stock market as part of the capital markets. They argue that stock markets are likely to hurt economic growth due to their susceptibility to market failure, which often manifest in the volatile nature of stock markets in many developing countries Singh and Weiss (1998). In fact, some consider stock markets as “casinos” which have little impact and potentially negative effect on economic growth Singh (1997) and Levine and Zervos (1996). They are of the view that stock market development rather has a negative relationship with economic growth. Again, the traditional growth theorists believe that stock market development and economic growth are not correlated because of the level effects of the former Pagano (1993) and Shahbaz et al. (2008).

Levine and Zervos (1996, 1998) also support the view that stock markets promote economic growth. They observe that the development of stock markets is positively related with the level of economic development and accumulation of capital. Hence, stock markets are not “casinos”. This means that the development of stock markets matters a lot since they channel both domestic and foreign capital into productive investible projects as well as the provision of liquidity. The fact is that well-functioning stock markets, along with well-designed institutions and regulatory systems bring about economic growth.

Boyd and Smith (1998) present a framework in which both the debt and equity market impact on the level of economic growth. It states that both debt and equity markets are considered as complements rather than substitutes in financing investment. Blackburn et al. (2005) present a model which is similar to Boyd and Smith (1998). Their overlapping generation models consider the joint determination of both banks and stock markets as determined by state-dependent and moral hazard conditions. In this model, there is feedback effect from economic growth to the determination of financial structure be it banking or stock market or on a mixture of banks and stock markets. Capasso (2008) uses an optimal capital structure model to provide a link between components of stock market and long-term economic growth. He indicates a strong relationship between stock market and economic growth with firms showing greater preference towards issuing equity than debt as capital continues to accumulate. That is as the economy continue to grow, information costs continue to decrease as well so does the cost of equity relative to debt financing which promote the development of stock market.

2.3.1 Empirical Literature

Levine and Zervos (1998) emphasize on the fact that stock market liquidity measured and evaluated how stock market, banks and economic growth interact with one another using data on 47 countries from 1976 to 1993. The results show that both stock markets and banking development are positively and significantly related to economic growth and both are good predictors of economic growth. They use six measurements of stock market development, these are: a measure stock market sizes, two measures of stock market liquidity, a measure of stock market volatility and two measures of stock market integration. While on the banking measurement, they use Bank credit to private sector.

Rousseau and Wachtel (2000) use panel vector autoregression (VAR) with generalized method of moment techn