Stock Market Development and Economic Growth: Empirical Evidence from China

It is important to understand the interplay between stock market and real economy to figure out the various channels through which financial markets drive economic growth. In the current study we investigate this relationship for Chinese economy, the fastest growing and largest emerging economy in the world. Using the methodology of unit root testing in the presence of structural breaks and using an ARDL model, we find that Global Financial Crises had a significant impact on both China’s real sector and financial sector. Our findings also suggest that Shanghai A share market has a long run negative association with the real sector of the economy, however the magnitude of impact is tiny and can be ignored. We conjecture that this negative relationship is the proof of so called existence of irrational prosperity on the stock market and the bubbles in China’s financial sector. We do not find any evidence of a relationship between stock market and real economy in the short run. Toda Yamamoto causality test supports the demand-driven hypothesis that economic growth spurs development of stock markets for China’s B share market.