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The Effects of Banking Sector and Stock Market Development on the Malaysian Economic Growth: an Empirical Investigation

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THE EFFECTS OF BANKING SECTOR AND STOCK MARKET DEVELOPMENT ON THE MALAYSIAN ECONOMIC GROWTH: AN EMPIRICAL INVESTIGATION

BY HAFSAH AHMAD

A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR THE DEGREE OF DOCTOR OF PHILOSOPHY IN ECONOMICS

KULLIYYAH OF ECONOMICS AND MANAGEMENT SCIENCES INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

MAY 2005

1

ABSTRACT
This study investigates the long-run relationship between financial development (banking sector and stock market development) and economic growth in Malaysia. Six variables based on Malaysian quarterly data from 1978:1 to 2002:4 are employed, namely real GDP per capita, investment rate and ratios of credit, deposit, market capitalization, and value of shares traded to GDP. Two dynamic frameworks are adopted - Vector Auto regression (VAR) with error correction formulation for causality analyses and dynamic OLS (DOLS) procedure for estimation of growthfinance long-run relation. Causality analyses show that there is bi-directional causality between financial development (banking sector and stock market development) and economic growth. Analyses on growth-finance long-run relations indicate that banking sector development and stock market development individually have an independent positive effect on long-run economic growth. They enhance economic growth through both channels – the volume and efficiency of investment, with the latter being the main source of their independent effect. The study also shows that banking sector development and stock market development complement each other in the growth process. The study indicates that both bank-based and market-based aspects of financial development are important for long-run economic growth. The results may raise awareness and understanding of the finance-growth nexus to policymakers and practitioners.

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