Research works that help us understand the role of financial markets on economic growth will have a great deal of policy implications and will influence the priority that policy makers give in dealing with financial sector policies. In this regard, finance researchers have extensively investigated the role of finance in boosting economic growth. However, we still have little understanding of how stock market development promotes economic growth. In this strand of literature, how to measure the functionality of financial markets is a big empirical challenge. Researchers typically use stock market size, or total stock market capitalisation as a proxy for stock market functionality and do not find robust evidence to suggest that stock market size is associated with future economic growth.
We revisit the question of whether, and if so how, stock market development promotes economic growth. Theoretically, a good proxy for stock market development should capture the ease with which an entrepreneur or a firm with a good investment project can access required capital, that is, the functional efficiency of the stock market. We propose a new measure of stock market functionality termed “stock market concentration” We measure the extent of stock market concentration as the sum of the stock market capitalisations of the largest five or 10 firms divided by the total stock market capitalisation of a country’s domestic stock exchanges. The idea is that the structure of stock market, not just its size, can better capture the functional efficiency of stock market. In a concentrated stock market dominated by a few large firms, an entrepreneur with a good investment project may have more difficulty in obtaining required capital than in a stock market that is not. A more concentrated stock market then leads to less funding available to potential users of stock market financing.