Stock Market Volatility and Economic Growth in Nigeria (1980-2010)

IntroductionA common problem plaguing the low and slow growth of developing economies is the lack of depth of the financial sector. Although, financial markets play an important role in the process of economic growth and development by facilitating savings and channeling funds from savers to investors, the problem of high instability of the financial sector has adversely affected the proper functioning of the market. In the submissions of Poterba (2000), the unpredictability impairs the smooth functioning of the financial system and negatively affects economic performance. Also, it has been claimed that volatility in the stock market signals growth. It reflects investors sorting out which entities are economically weak or unviable and which are strong and poised for growth. If the stock market only declined, the case could be made that growth, too, was only declining Wang (2010). It is however clear from the literature that the issue of stock market volatility and economic growth still cause controversy among scholars and the results are therefore mixed. Evidently, there is need for more research on the volatility in stock market. Most related studies (see Abugri, 2008; Pierdzioch, et al 2008 and Vrugt, 2009) fail to model the instability in stock market. Also, very little attention is paid on the use of appropriate model selection criteria including pre-test as suggested by Engle (1982) to determine the choice of volatility model and validate the preferred model over other competing models. Although the importance of stock market volatility on economic growth has received much attention, the studies with respect to Nigeria have been few. This study intends to address these issues. In the next section, we present the review of literature while an overview of the Nigerian capital market is presented as Appendix 1.Literature ReviewThe stock market is an ever-growing important feature of the economy. One of the most enticing and longlasting debates in economics revolves around whether or not there is a link between stock market volatility and economic growth. Many researches focus on the relationship between stock market volatility and macroeconomic performance (real output, inflation, investment). The recent empirical investigations provide mixed results.On one hand is the view that stock market volatility is significantly and positively correlated to economic growth (see Ahmed & Samad, (2008); Levine & Zervos, 1998), while on the other hand, there is still doubt on its contribution to long-run-economic-growth. Indeed, some analysts even claim that stock market volatility has an adverse effect on the economy (Adjasi & Biekpe, 2006). Most studies however tend to focus mainly on the developed countries (Ahmed 2005; Levine & Zervos, 1998) while existing literature in African regions is scarce (Osinubi, & Amaghionyeodiwe, (2003); Rahman & Rahman, 2007; Chinzara, 2011). Though the importance of stock market volatility on economic growth has received much attention, a highly inadequate number of research works have been done to investigate whether or not there is a relationship between stock market volatility and economic growth in the case of Nigeria economies.Campbell et al. (2001) suggests that stock market volatility has significant predictive power for real GDP growth. However, Guo (2002) shows that the relationship between stock market volatility and economic activity is not fully robust to deserve model specifications. In regressing GDP growth on contemporaneous stock market volatility, Guo finds a significant and negative effect on GDP growth. However, once controlled for the current stock market return or for the current and past return jointly, the effect of instability tends to weaken or becomes insignificant. Hence, the conclusion from his work is that stock market returns drive out stock market volatility in forecasting output and, therefore, beyond stock market returns the volatility of the stock market provides no additional information about future output. …