Causality Relationship between Macroeconomic Variables and Stock Market Development: Evidence from Bahrain

This paper investigates the relationship between macroeconomic variables and Bahraini stock market development by using the Autoregressive Distributed Lag model. The development of a financial market is closely related to the overall development in the national economy. Well functioning financial system achieves efficiencies that provide good and easily accessible information, lower transaction costs and efficient resource allocation then boost economic growth. Many macroeconomic variables have significant effects on a stock market and its functions, development, and role in the national economy. The central bank actions, governmental policies and individual behavior affect the financial system development. For instance, monetary policy links with stock market development through affecting money supply, interest rates, investment activities in stocks and the market values of stocks. Expansion monetary policy raises money supply, decreases interest rates and raises investment in stocks and market values of stocks. A similar effect can be done by fiscal policy but the effect will be gone directly through interest rates and investment. The main findings of the paper are that income level, domestic investment, banking system development; private capital flows and stock market liquidity are important determinants of Bahraini stock market development. The results of the paper support the theoretical and empirical literature on macroeconomic variables and stock market development nexus.