Dynamics of Market Capitalization and GDP Relationship

Gross Domestic Product or GDP is a commonly used measure of a country's economic development where market capitalization signifies the performance of stock market. N. Gregory Mankiw in his book “Principles of Macroeconomics” has defined GDP as “the market value of all final goods and services produced within a country in a given period of time”. In DSE website, Market Capitalization is stated as “the total market value, at the current stock exchange list price of the total number of equity shares issued by a company”.  It is calculated by multiplying the individual share price of a company with total number of common share outstanding of that company. For the whole market, this is simply the summation of market capitalization of all companies listed in that market.

Now, why do I think there might be a relationship between GDP and Market Capitalization? Firstly, why does the market capitalization of a company increase or decrease? Market capitalization would increase if the investors pay higher price per share. Why would the investors do this? The investors will do this if they find that the company is doing well in terms of revenue or margin or think that the company will do well in foreseeable future and they would be in the side of winners by holding that stock (this is just one of the many reasons as the price per share may increase for reasons those have no relation with particular company). If the revenue increases, there must be the increase of quantity sold or price. Irrespective of increase in quantity sold or price, the impact on GDP would be positive because “increased quantity sold” implies the increase in production of final goods and services and “price increase” means the increase in market value of final good and services. So, if any of these increases, GDP will increase. This logic can be reversed also. Low market capitalization because of lower revenue, so, lower quantity sold or lower price, therefore, lower GDP.

To check this relationship mathematically, I’ve considered the GDP of Bangladesh and total market capitalization of Dhaka Stock Exchange (DSE) for 20 years from 1996-97 to 2015-16. Here, GDP is the GDP at current market price. GDP and Market Capitalization data are collected from the Monthly Economic Trend, August 2016 issue published by Bangladesh Bank. Ordinary least square (OLS) regression is run by considering total market capitalization as independent variable and GDP as dependent variable. The null and alternative hypotheses are

Null: There is no significant relationship between GDP and Market Capitalization in Bangladesh

Alternative: There is significant relationship between GDP and Market Capitalization in Bangladesh

The result of the regression is presented in table 01. The correlation coefficient is 0.9394 which indicates a high degree of association between the variables. Coefficient of determination shows that 88.25% of the variation of GDP can be explained by the change in market capitalization. Significance F value in lower than 0.05, therefore, this model is statistically valid.

Table 01: Regression Result of GDP and Market Capitalization

Regression Statistics
Multiple R	0.9394
R Square	0.8825
Adjusted R Square	0.8760
Standard Error	168866.1032
Observations	20.0000

ANOVA
	df	SS	MS	F	Significance F
Regression	1	3.856E+12	3.856E+12	1.352E+02	8.352E-10
Residual	18	5.133E+11	2.852E+10
Total	19	4.370E+12

	Coefficients	Standard Error	t Stat	P-value	Lower 95%	Upper 95%	Lower 95.0%	Upper 95.0%
Intercept	248602.682	52011.215	4.780	0.000	139331.175	357874.190	139331.175	357874.190
Mkt Cap	4.276	0.368	11.629	0.000	3.504	5.049	3.504	5.049

Coefficient of intercept is 248602.682 which denotes the change in GDP for the factors outside of this model. Market capitalization is showing a positive coefficient value with GDP. Other things being constant, for one unit change in market capitalization, GDP will change by 4.276 units.  The p-value of market capitalization is lower than 5%. So, the null hypothesis can be rejected and it can be concluded that there is a significant relationship between GDP and market capitalization in Bangladesh.