Abstract
There has been a series of intensive debate on whether financial market development has the potential to impact positively on
long run economic growth of an economy. Thus, this study empirically examines the impact of financial market development on
economic growth in Nigeria using annual time series data covering the period of1981-2014. In achieving this, the study
employed the Vector Error Correction Model (VECM) as the econometric methodology. The empirical results show that overall
there is a positive effect of financial market development on economic growth in Nigeria. Almost, all the financial markets,
namely, stock, capital and money market have been found to have a significant positive impact with the exception of only foreign
exchange market having a negative impact on economic growth. On the basis of the findings of the study, it was recommended
that there is a need for a comprehensive financial reform to overhaul the entire Nigerian financial system so as to boost business
and investment activities in the country. The study also recommended for the establishment of effective legal framework to
complement the regulatory and supervisory institutions as well as directing the financial reform and credit policy of the apex
bank towards improving credit to private sector. Finally, the study recommended a more flexible foreign exchange rate policy
and diversification of the export base of the country to make the forex market a positive contributor to the nation's real GDP.
Keywords: Financial markets, Economic growth, Cointegration, Error Correction Mechanism (ECM). JEL
Classification: C50, D53, G20, O43 1. Introduction
There have been a series of intensive debate among various economists, policymakers, academicians and even among theoretical
thinkers about the key roles of financial market in the growth process of an economy. Majority of the researchers have
considered financial market development as an integral part of economic growth. According to Wachtel (2001), there are four
medium through which financial market can support economic growth. First, financial markets allocate funds from the surplus
sectors to the deficit sectors of the economy ; second, they provide incentives and innovative mechanisms for mobilising
savings; third, they reduce the costs associated with evaluation and implementation of projects through large scale economies
and enhance monitoring through corporate governance; and lastly, they reduce the problems associated with risk in business by
ensuring symmetry information , thereby enhance provision of liquidity and risk sharing.
Financial markets are the markets where stocks, bonds, commodities, foreign exchange and even derivatives are traded to raise
cash for government or businesses, reducing companies' risks and increasing investors' wealth (Amade o, 2013). The Nigerian
financial market comprises the money market, capital market, stock market and foreign exchange market as well as the
institutions and channels that facilitate the smooth intermediation of financial transactions in the economy. Financial markets are
also synonymous with the financial services sector which is made up of the banking system, other financial institutions, and the
securities, insurance and pension sub-sectors (Central Bank of Nigeria, 2009). According to Abiola and Okoduwa (2008), the
financial market consists of two major segments, the money market and the capital market. The money market provides finance
on short-term basis to individuals while the capital market provides finance to businesses, enterprises, corporate bodies,
government agencies etc on a medium to long term basis. They emphasize that money market and capital market plays a key
role in the growth of financial system of every economy and it an important medium of generating funds to finance projects and
investments that would lead to economic growth. Also, Al-faki (2006) contend that the capital market is a network of specialized
financial institutions with series of mechanism, processes and infrastructures that in various ways, facilitate the bringing together
of suppliers and users of medium to long term capital or fund for investment and economic development projects.
Although, several researchers have been conducted studies on the relationship between financial market development and
economic growth in Nigeria; however, the results of the studies are inconclusive in view of the mixed findings reached,
especially on the channels through which financial market development and economic growth are related. The early study by
McKinnon (1973) found that financial market development influences economic growth through a process of capital
accumulation (both domestic and foreign) and technological change, which is aided by incentives namely, promotion of local
saving rate. Berthelemy and Varoudakis (1996) argue that the competitiveness of the banking sector has a direct effect on the
steady state growth rate, through a process of well-functioning educational system. Meanwhile, Greenwood and Jovanovic
(1990) found that the financial system impacts on the economic growth through the contribution of more productive investments
and increased capital allotment.
It is on the basis of these inconclusive results of previous studies that this study is carried out. Therefore, the study seeks to
investigate empirically the role of financial market development on economic growth in Nigeria between the period 1981-2014,
1
Financial Market Development and Economic Growth in Nigeria: Evidence from VECM Approach
Abubakar Hassan, Omoshola D. Babafemi, Aminu Hassan Jakada
with focus on four major types of financial market, namely, capital, stock, money and forex market. The remaining part of
this paper is divided into four sections as follows. Section 2; examined existing literatures in line with the research topic.
Section 3; discusses the methodology to be employed, Section 4; deals with the analyses of the data obtained and section 5;
concludes the paper and provides policy recommendations for the study.
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