(Ahmed, Ali & Shahbaz, 2008)
In 19th and 20th centuries, academicians such as Bagehot (1873) and Schumpeter (1911) had focused on contribution of financial sector to economy. The main function of money or capital in the initial years was to trade in credit for the purpose of financing development before the Great Depression. Gurley and Shaw (1955) were the first to study the relationship between financial markets and real activity. However, the direct relationship was not very clear until recently. Recent literature has paid much attention to banking reforms which directly affected both the stock markets and economic growth relationships. Levine (1997) suggested that liquid market spread can lead to stable and long term investments leading to economic growth through reduced transaction expenditure. While the conventional economists always believed that there was no direct relation between stock market growth and economic growth because of presence of level effect and not the rate effect. Many of them in fact believed that stock markets actually harm the economic growth due to its volatile nature, market flexibility due to unstructured and unexplainable sentiments and generally no justification for sudden surge or fall in stock indexes leading to perceived gains and losses of millions of dollars in a fraction of a day.
However, there has been considerable growth of stock market share in economic direction of a country. During late 90s over a period of a decade, the total value of world's stock markets rose from $4.7 trillion to $15.2 trillion while capitalisation share jumped fro 4% to 13%. (Levine 1998). The figures have since seen exponential growth in the past decade too, with world economy growing steadily between 6 to 10% in developing countries, and around 5% in developed world.
These emerging markets have attracted international investors leading policymakers to always wonder as to how the stock markets can affect overall economic development, about their relationship and how can developing countries derive maximum benefit from these markets (Levine 1998)
It has been generally accepted that well organised stock markets attract investments by promoting productive projects leading to economic activity within the market. It stimulates domestic savings, allocates capital proficiency, diversifies risks and facilitates exchange of goods and services. (Mishkin and Caporale et al as mentioned in Ali et al, 2008) One of the major advantages of developing economies was better developed financial system. Thus investors could be provided with adequate funding for their projects. Financial markets also contributed to economic development through better physical capital accumulation. During late 60s and early 70s, researchers found significant correlation between stock markets and per