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The results from the previous section suggest that large corporations in Africa have made
considerable use of the stock market to finance their growth. In this section, we examine the
larger-economy wide positive effect of stock market development in Africa. Stock market
development has assumed a developmental role in global economics and finance following
the impact stock markets have exerted in corporate finance and economic activity. For
instance, due to their liquidity, stock markets enable firms acquire much needed capital
quickly, hence facilitating capital allocation, investment and growth. Stock markets also help
to reduce investment risk due to the ease with which equities are traded. Stock market
activity is thus rapidly playing an important role in helping to determine the level of
economic activities in most economies.

We examine if stock markets have economy-wide effects on sub-Saharan African economies.
We look at the effect of stock markets on economic growth through three stock market
indicators—market capitalization relative to GDP, value of shares traded relative to GDP,
and the turnover ratio (value traded/market capitalization). The modeling and estimation
follows the framework of Levine and Zervos (1998). The essential issue is to estimate the
model in a manner dynamic enough, but at the same time removing all country-specific and
time effects which may be correlated with the explanatory variables, hence introducing errors
and biases. In this regard, the study adopts the Arellano and Bond (1991) Difference
Generalized Method of Moments dynamic instrumental variable modeling approach, where
the lagged values of the dependent variable (growth) and differences of the independent
variables are suitably used as a valid instrument to control for this bias and the obvious
endogeneity between lagged growth values and lagged errors.
The data is an unbalanced panel of 14 African countries. The stock market indicators are
obtained from Reuters Services and Emerging Stock Markets Fact Book and the
macroeconomic indicators are from the International Financial Statistics of the IMF. Since
some of the stock market indicators (for example, the capitalization ratio) are ratios of stocks
and flows, there is a stock-flow problem, with regards to the timing of their computation. The
stock-flow problem is dealt with according to Beck, Demirgüç-Kunt and Levine (1999).6 The
macroeconomic variables include GDP, investment (gross domestic fixed capital formation
as a proxy) and trade openness (sum of exports and imports relative to GDP).
From the literature an increase in stock market activity should increase economic growth
through liquidity injection, savings mobilization and equity financing for firms. Thus, we
expect a priori that an increase in market capitalization ratio, turnover ratio or value of shares
traded ratio should increase economic growth. The other control variables for GDP growth
are investment (Gross Capital Formation), trade openness and initial income. Again as per
growth literature it is expected that trade openness and investment is positively correlated
with growth. The three stock market indicators enter the model separately in order to
determine which indicator is the best channel through which stock markets influence growth.
This is in tune with Filer, Hanousek and Campos (1999) and Bekaert et al (2004) who have variously noted the relevance of turnover ratio and value traded over market capitalization.
The results show that stock markets influence economic growth significantly through the
value of shares traded ratio.

The results from the regression model are interesting. In Equation 1 (Table 4), which uses the
ratio of market capitalization to GDP as the stock market development indicator, stock
market development does not have a significant effect on economic growth. The most
significant variables here are lagged growth and investment which positively influence
growth. In Equation 2, however, stock market development plays a significantly positive role
in economic growth alongside investment and past growth levels. The stock market
development indicator used here is the total value of shares traded relative to GDP, which is
indicative of liquidity on the stock markets. An increase in stock market activity via higher
liquidity augments GDP growth significantly by a substantial 3.7 percentage points. In the
case of the third equation, stock markets (turnover ratio) do not significantly affect economic
growth, even though a significant effect of turnover ratio on economic growth would also
reaffirm the effect of stock markets in growth due to the absence of a price effect in this
indicator. The robustness and validity of the Difference GMM estimation is checked via the
Sargan and serial correlation tests.

From the empirical analysis, the significant stock market driver of economic growth in Africa
is the ratio of value of shares traded to GDP. It is important to note that the ratio of value
traded relative to GDP is an indicator of the activity and liquidity of the stock market. Hence
improvements in trading of shares (in the number of shares traded, frequency and efficiency
in trading) or liquidity on African stock markets will on the whole boost economic growth by
3.7 percentage points. The adoption of electronic trading systems and the encouragement of
new listings could boost this liquidity on African stock exchanges. It must also be added,
however, that the inclusion of South Africa in this group could have led to a heavy bias
towards this result. Nonetheless, this finding is suggestive of where policy should be directed
with regards to stock markets in Africa.

IMF Working Paper
African Department
Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges
Prepared by Charles Amo Yartey and Charles Komla Adjasi
August 2007

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