3.1 Introduction
In most empirical studies the problem was how to measure financial intermediation and the indication of the level of financial services produced in the economy. There are various services available to the financial sector and this is the reason why it is so difficult to construct financial development indicators. The aim of this chapter is to empirically investigate the possible relationship that exists between financial markets and economic growth. The variables used to determine the causality between financial development and economic growth are Gross Domestic Product (GDP) growth percentage and Foreign Direct Investment (FDI) which are both indicators of economic growth. Claims on private sector and the equity turnover …show more content…
Thangavelu et al. (2004) mentions that causality tests are sensitive to the lag length in the VAR, and therefore we use the Akaike Information Criterion (AIC) and Schwarts Information Criterion (SIC) to determine the optimal lag length.
The Granger Causality Test
In this study the Granger causality test is also conducted to examine the relationship between financial development and economic growth. Granger (1969) said that “X causes Y if the past values of X could provide a better estimation of Y than simple using the past value of Y”. In other words, if the past value of X statistically improves the estimation of Y, then it can be concluded that X Granger-cause Y (Nguyen & Pham, 2014). The null hypothesis is:H_0: Financial development does not cause economic growth. This hypothesis is tested by means of the following formulas: y_t= a_1+ ∑_(i=1)^n▒〖β_i x_(t-i) 〗+ ∑_(j=1)^m▒〖γ_j y_(t-j) 〗+ e_1t x_t= a_2+ ∑_(i=1)^n▒〖θ_i x_(t-i) 〗+ ∑_(j=1)^m▒〖δ_j y_(t-j) 〗+