Stock Market Bubbles and their Determinants: An Empirical Investigation on the Developing Economies

Abstract

A country’s stock market is a fundamental pillar of the country’s economy that reflects investors’ sentiment and propels economic growth. Changes in the monetary policy, i.e., interest rate and money supply, contribute to the formation of stock market bubbles. In the developing stage of the bubble, economic activity increases significantly. On the contrary, economic activities slow down in the event of a bubble burst. Historically, financial experts have observed that extensive credit growth or asset market bubbles usually lead to financial crises. Credit growth usually stems from the reduction of interest rates and weaker regulatory control, while stock market bubbles are influenced by GDP growth. So, the need for early detection of the stock market bubble increased in developing economies. This study first detected the stock market bubbles in the leading index of 49 developing economies from 1991 to 2022 and observed bubbles in 41 (i.e., 83.67%) leading stock exchange indexes of the developing countries. Secondly, this study proved that interest rates have a heterogeneous impact of interest rates on the stock market bubble. Thirdly, confirmed that the money supply (M2) positively impacts the stock market bubble. This study contributed in numerous ways, i.e., by identifying the bubbles in the leading stock exchanges and identifying the determinants of the stock market bubble in the developing economies, i.e., the interest rate, money supply (M2), and gross domestic product proxied by industrial growth. Secondly, identified the determinants of the stock market bubbles in developing economies from 2001 to 2022, particularly Pakistan