The World Federation of Exchanges (WFE), the global industry association for exchanges and central counterparties (CCPs), has published new research on how stock market changes affect economic growth, investment and the wider economy.
The paper, Stock Market Transmission to the Real Economy: A Macro–Finance DSGE Approach by WFE Research economist Dr Ishak Demir, develops a theoretical framework that proposes and quantifies four channels through which equity market conditions shape macroeconomic outcomes:
- the effect of equity wealth on consumption;
- a valuation channel through which equity price changes influence business investment;
- a balance-sheet channel that eases or tightens external financing conditions;
- a productivity channel through which equity market development improves capital allocation.
The research finds that changes in equity prices affect the economy principally by influencing firms’ investment decisions, and this effect is stronger in advanced economies, where equity markets are deeper and more closely linked to corporate finance.
By contrast, long-term improvements in equity market depth, liquidity and institutional quality operate mainly through the productivity channel, and produce larger investment gains in emerging market and developing economies, where financial constraints are more binding and the potential to improve capital allocation and productivity is greater.
The findings highlight the different ways in which equity markets affect economic activity as financial systems develop, with stronger investment responses to market development in emerging and developing economies.
Dr Pedro Gurrola-Perez, Head of Research at the WFE, said: “The research shows that equity markets affect the real economy in different ways depending on the structure of the financial system.
“In advanced economies, changes in equity valuations have stronger effects through the investment channel, while in emerging and developing economies, improvements in equity market development generate larger investment responses through the productivity channel.
“The research reinforces the view that exchanges are not simply venues for trading financial instruments, but essential components of a country’s productive infrastructure. The quality of equity-market institutions – the rules governing listing, disclosure, investor protection, and trading – shapes how efficiently an economy allocates capital, finances innovation, and raises productivity.”
Nandini Sukumar, CEO of the WFE, said: “Exchange groups are vital to the growth and development of any nation: large or small. They are an economic imperative and a vital tool in the path to prosperity.
“This research demonstrates how equity markets have an important role to play in supporting investment and economic growth.
“This research also shows that developing equity markets can have a particularly strong effect where access to finance is more constrained highlighting why deep, liquid and well-functioning equity markets matter to the economies they serve.”
Read the full paper, Stock Market Transmission to the Real Economy: A Macro–Finance DSGE Approach.
Source: WFE
