Investigating Causal Relationship between Financial Development Indicators and Economic Growth: Toda and Yamamoto Approach

The Causal relationship between financial development and economic growth has received divergent views in the literature under the traditional Granger approach to causality using data from various countries. The more recent Toda and Yamamoto and Dolado and Lütkepohl (TYDL) approach to causality were used to investigate the causal relationship between financial development and economic growth in Nigeria for the period 1985 to 2015. TYDL is based on an augmented VAR modeling and it is adjudged more robust to order of integration of the variables when compared with Granger framework. The maximum order of integration was two while the optimal lag length of three was selected by FPE, AIC and HQ criteria. Bi-directional causality was found between financial markets indicators and economic growth while unilateral causality running from stock market indicators to GDP was established. The findings support existing studies that agree with the fact that a well-structured financial sector breeds economic growth and this by implication suggests, it is imperative for the government of Nigeria and other developing countries to create an atmosphere for a thriving financial sector and engage in reforms that will stimulate the economy.