Market capitalization and growth with nominal and real rigidities: the case of emerging economies
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Market capitalization and growth with nominal and real rigidities: the case of emerging economies Agnirup Sarkar1
© Editorial Office, Indian Economic Review 2020
Abstract The purpose of the paper is to explain the positive and significant correlation between market capitalization as a ratio of GDP on the one hand and growth of per capita GDP on the other especially for emerging economies as revealed by annual data of 32 years for 35 countries. For this purpose, a New Keynesian DSGE model with nominal rigidity in the form of price stickiness and real rigidity in the form of investment adjustment cost is constructed. The positive and significant correlations observed from the data match the ones obtained from the model only for relatively small values of the price stickiness parameter, which is characteristic of emerging economies since the latter experience frequent price changes and high inflation, a fact established empirically. Both real and nominal frictions are crucial in reproducing the desired result. Keywords Growth · Stock market · Emerging economy JEL Classification E5 · E6 · G1
1 Introduction The purpose of the paper is to provide a theoretical explanation of the contemporaneous relationship between performance of the stock market and performance of the economy. There is a vast theoretical literature relating GDP or its growth to the levels of stock market activities of a country. The theoretical literature can be The paper is based on a chapter of the author’s doctoral thesis submitted to Durham University, UK. The author wishes to thank, without implicating, Parantap Basu, Elisa Keller, Thomas Renstrom, Neil Rankin and an anonymous referee as well as seminar participants at UWE Bristol, Durham Business school, Delhi School of Economics, Indian Statistical Institute, Delhi and Kolkata, Jadavpur University, Centre for Studies in Social Sciences and North–South University. * Agnirup Sarkar [email protected] 1
Indian Institute of Technology, Guwahati, India
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divided into two broad groups. The first group has emphasized financial intermediation in general and stock market development in particular, as a major determinant of long run growth. This strand of literature goes as far back as Schumpeter (1912) and Hicks (1969) and culminates in more recent work by Jacklin (1987), Gorton and Pennacchi (1990), Bencivenga and Smith (1991), Levine (1991), Japelli and Pagano (1994) and Bencivenga et al. (1995), among others. In this literature, stock markets act as an efficient bridge between savers and investors, thereby facilitating capital accumulation and growth. The question of contemporaneous relationship between stock market and growth is not addressed in this literature. The second strand of literature, based primarily on the asset pricing model of Lucas (1978), views stock markets as a major outlet for savings. In this approach, income or its growth is stochastic. A positive income shock increases savings and hence the demand for stocks through the income effec
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