Stock market and economic growth in Eastern Europe

A developed financial system is essential in a market economy. The ultimate aim of the financial system is to canalize savings generated by surplus spending units to deficit spending units. Similarly, economic growth is very important for institutions and economic policy, because the concept of economic growth is often associated with the prosperity and well-being of a country.

This paper studies the importance of the development of financial markets in general, and the stock market in particular, from the review of existing literature on the relationship between financial development and economic growth, and especially, the link between the stock market and economic growth. Through an empirical analysis of six countries in Eastern Europe (Bulgaria, Slovakia, Hungary, Poland, Czech Republic and Romania), we attempt to show the link between the development of the stock market and economic growth in these countries.

An econometric model with economic and financial variables is analyzed, which tries to examine the relationship among all the variables, and if there is Granger causality between financial variables and economic variables. The economic variables used are Gross Domestic Product (GDP) and Foreign Direct Investment (FDI). The financial variables used are Market Capitalization, stock Total Traded Value (TTV), and the Turnover Ratio (TR). The financial variables measure the development of the stock market. Specifically, a Vector Autoregressive model (VAR) is used with the aim of studying Granger causality between the variables. Data have been collected from the World Development Indicators Website.  The study data are annual observations covering 1995 to 2012, used to explain the transition of these communist countries to market economies, which began with the demolition of the Berlin Wall in 1989.