The causality between stock market and banking sector: evidence from dual banking system

Abstract

The Stock market and Banking sectors have frequently been lumped together as one, and named the financial sector, even though they appear to be different in nature and in functions. Based on this assumption only a few studies have been undertaken to determine causality between them. Without knowing the accurate lead-lag relationship between these two important fniancial sectors, policy-makers would prescribe for them similar treatments. This could hurt either of these sectors. Both theoretical and empirical studies have not been able to resolve the controversy surrounding the direction of causality between the stock market and banking sector development. Therefore, the objective of this paper is to determine which financial sector leads, the stock market or banking sector. Using standard time series econometric method, monthly data covering a period of about 22 years were analyzed. The results indicate that stock market Granger-causes banking sector development, with GDP, sandwiched between them. Policy-makers who are desirous of developing the banking sector may do so through influencing (hitting) the stock market or economic growth. However, to develop the stock market, the main option available is to try and influence interest or exchange rates.