Empirical Banking Finance and Growth Levine and Zervos PDF

Empirical Banking Finance and Growth LEVINE and ZERVOS Stefano Caiazza 2024-2025  Key elements of Levine and Zervos (LZ) Research Question: Do well-functioning stock markets and banks promote long-run economic growth? Empirical investigation: Liquidity, size, v...

Empirical Banking Finance and Growth LEVINE and ZERVOS Stefano Caiazza 2024-2025  Key elements of Levine and Zervos (LZ) Research Question: Do well-functioning stock markets and banks promote long-run economic growth? Empirical investigation: Liquidity, size, volatility, integration → current and future growth rate Problem to address: Measuring Stock Market and Banking Development Data and countries The time spanning from 1976-1993, 47 countries Econometric analysis  The research question and main findings Empirically, King and Levine (1993a) show that the level of financial intermediation is a good predictor of long-run economic growth rates, capital accumulation, and productivity improvements. Moreover, we integrate this study into recent cross-country research on financial intermediation and growth by extending the King and Levine (1993) analysis of banking and growth to include measures of the functioning of stock markets. Specifically, we evaluate whether banking and stock market indicators are both robustly correlated with current and future rates of economic growth, capital accumulation, productivity growth, and private saving. Main finding: Banking development and stock market liquidity are both good predictors of economic growth, capital accumulation, and productivity growth.  Measuring Stock Market Development (1) Size - Capitalization measures the size of the stock market and equals the value of listed domestic shares on domestic exchanges divided by GDP. (2) Liquidity indicators: The Turnover ratio is the value of the trades of domestic shares on domestic exchanges divided by the value of listed domestic shares (a proxy for transaction costs). https://data.worldbank.org/indicator/CM.MKT.TRNR?view=chart [download CSV/Excel] The Value Traded is the value of domestic shares traded divided by GDP. https://data.worldbank.org/indicator/CM.MKT.TRAD.GD.ZS [download CSV/Excel] While the Turnover measures trading relative to the size of the stock market, Value Traded captures trading relative to the size of the economy. Thus, a small, liquid market will have a high Turnover but a small Value Traded ratio. (1)&(2): If markets anticipate large corporate profits, stock prices will rise today. This price rise would increase the value of stock transactions and, therefore, raise the Value Traded. The liquidity indicator would rise without a rise in the number of transactions or a fall in transaction costs. One way to gauge the influence of the price effect is to look at Capitalization and Value Traded together. The price effect influences both indicators, but only the Value Traded directly relates to trading. Therefore, we include both Capitalization and Value Traded indicators together in our regressions. A second way to gauge the importance of the price effect is to examine Turnover. The price effect does not influence Turnover because stock prices enter the numerator and denominator of Turnover.  Measuring Banking Development Researchers often divide the stock of Broad Money (M2) by GDP to measure financial depth. As noted by K&L (1993), however, this type of financial depth indicator does not measure whether the liabilities are those of banks, the Central Bank, or other financial intermediaries, nor does this financial depth measure identify where the Financial System allocates capital. Bank credit: The value of loans made by commercial banks and other deposit-taking banks to the private sector divided by GDP.  Measuring Growth Output Growth is the long-run real per capita GDP growth. Capital Stock Growth is the rate of real per capita physical capital stock growth (KL). Productivity Growth is everything else (KL). Savings is private savings (as a percentage of GDP). Data Data on 47 countries from 1976 through 1993 Descriptive Statistics  Econometric specification The growth indicators are averaged from 1976 - 1993. There is one observation per country. The dependent variable is either Output Growth, Capital Stock Growth, Productivity Growth, or Savings averaged over 1976-1993. L&Z organize the investigation around the four stock market development indicators and always control the level of banking development (independent variables). Control variables: they include a wide array of control variables, X The logarithm of initial real per capita GDP (Initial Output) The logarithm of the initial secondary-school enrollment rate (Enrollment) The number of revolutions and coups (Revolutions and Coups): political instability is negatively associated with economic growth Macroeconomic indicators: The initial values of Government Consumption Expenditures to GDP, (Government) and the Rate of Inflation (Inflation)  Results 1a These results are consistent with the view that stock market liquidity and banks facilitate long-run growth. The estimated coefficient implies that a one standard deviation increase in initial stock market liquidity (0.3) would increase per capita growth by 0.8 percentage points per year (0.027*0.3) over this period. Accumulating over 18 years implies that real GDP per capita would have been over 15 percent higher by 1994 {exp (18 × 0.008 )}. A one standard deviation increase in initial banking development (0.5) would increase Output Growth by 0.7 percentage points per year (0.013 × 0.5). Results 1b Results 2  Sensitivity analyses (robustness checks) They conducted a wide array of sensitivity analyses to check the robustness of these results. A different set of alternative explanatory variables (legal efficiency, quality of institution) King and Levine (1993) measure of financial depth An alternative measure of stock market liquidity (value traded / volatility) Outliers (2 procedures) (1) The first procedure identifies countries that significantly affect each equation's residuals. Using a critical value of 2.5, we find that removing particularly influential observations does not affect our conclusions. (2) The second procedure uses scatterplots of the partial relationship between the growth indicators and the individual stock market indicators to identify outliers that may excessively influence the slope and significance of the estimated regression line.  Conclusion L&Z find that, even after controlling for many factors associated with growth, stock market liquidity and banking development are positively and robustly correlated with contemporaneous and future economic growth rates, capital accumulation, and productivity growth. Furthermore, since measures of stock market liquidity and banking development both enter the growth regressions significantly, the findings suggest that banks provided different financial services from those provided by stock markets. Thus, to understand the relationship between the financial system and long-run growth more comprehensively, we need theories in which stock markets and banks arise and develop simultaneously while providing different financial services to the economy.  Financial Development Measures https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/financial-development https://www.worldbank.org/en/publication/gfdr/data/global-financial-development-database  Comments Size = Market Capitalization The value of listed domestic shares divided by GDP GDP Value Traded = Value of Trades The value of the trades of domestic shares divided by GDP GDP Value of Trades Turnover ratio = The value of the trades of domestic shares on domestic exchanges Market Capitalization divided by the value of listed domestic shares If markets anticipate large corporate profits, stock prices will rise today. Prices rise would increase the value of stock transactions and therefore raise Value Traded. The liquidity indicator would rise without a rise in the number of transactions or a fall in transaction costs. One way to gauge the influence of the price effect is to look at Capitalization and Value Traded together. The price effect influences both indicators, but only the Value Traded is directly related to trading. Therefore, we include both Capitalization and Value Traded indicators together in our regressions. A second way to gauge the importance of the price effect is to examine Turnover. The price effect does not influence Turnover because stock prices enter the numerator and denominator of Turnover. Therefore, we include both Capitalization and Value Traded indicators together in our regressions.  Comments Researchers often divide the stock of Broad Money (M2) by GDP to measure financial depth. As noted by King and Levine (1993), however, this type of financial depth indicator does not measure whether the liabilities are those of banks, the Central Bank, or other financial intermediaries, nor does this financial depth measure identify where the Financial System allocates capital (page 542). Bank credit: The value of loans made by commercial banks and other deposit-taking banks to the private sector divided by GDP What is missing for banking? The quality! For example, Non-Performing Loans (NPLs)  Comments Output Growth is the long-run real per capita GDP growth. Capital Stock Growth is the rate of real per capita physical capital stock growth (King&Levine) Productivity Growth is everything else (King&Levine) Savings is private savings: equals gross private savings from Paul Masson et al. (1995). Page 542. Data Data on 47 countries from 1976 through 1993  Descriptive Statistics King and Levine Levine and Zervos  Comments The growth indicators are averaged from 1976 - 1993. There is one observation per country. The dependent variable is either Output Growth, Capital Stock Growth, Productivity Growth, or Savings averaged over 1976-1993. LZ organize the investigation around the four stock market development indicators and always control the level of banking development (independent variables). Control variables: they include a wide array of control variables, X The logarithm of initial real per capita GDP (Initial Output) The logarithm of the initial secondary-school enrollment rate (Enrollment) The number of revolutions and coups (Revolutions and Coups): political instability is negatively associated with economic growth Macroeconomic indicators: The initial values of Government consumption expenditures to GDP (Government), and the inflation rate (Inflation) Results 1  Results 2 Descriptive statistics?  Comments Outliers (2 procedures) (1) The first procedure identifies countries that significantly affect each equation's residuals. Using a critical value of 2.5, we find that removing particularly influential observations does not affect our conclusions. (2) The second procedure uses scatterplots of the partial relationship between the growth indicators and the individual stock market indicators to identify outliers that may excessively influence the slope and significance of the estimated regression line.  Instrumental variables approach The next subsection (II, pag. 543 on, CAPM and APT) uses instrumental variables to examine the link between the growth indicators, banking development, and measure of capital market integration. We use instrumental variables because the international integration measures are estimated regressors. What are the instruments? (Note 13, page 550) An alternative approach for instruments Lewbel A., 2012. Using Heteroscedasticity to Identify and Estimate Mismeasured and Endogenous Regressor Models. Journal of Business and Economic Statistics, 30(1), 67-80. Stata estimator: ivreg2h Ventura M., 2018. Testing the validity of instruments in an exactly identified equation. International Journal of Computational Economics and Econometrics, 8(2), 159-169.