Essays on Economic Growth and Financial Stability in Emerging Economies

This thesis contains three studies on economic growth and financial stability in emerging economies; economic growth has been at the center of discussion in any democratic society. The quest by mankind to improve the material standards of living a notion spawned by the 18th century's Enlightenment spread through Europe and North America. However, the demonstrable driver of economic progress is competition and protection of private property. Individuals do not exert the effort to accumulate the capital necessary for economic growth unless they can own it. The first study examines the existing literature on economic growth models and uses a survey method to discuss the recent developments from different perspectives. During the second half of the twentieth-century economists have built newer models of economic growth that consider policy influences of growth and divergent outcomes among countries. These models address issues concerning economic growth, the operation of financial markets, trade policy, government expenditures, and taxation. In this essay we have revisited the interdependence of political and economic institutions, taking the neoclassical growth model of [Solow1956] as a point of departure, which maintains that capital accumulation, population growth and technological progress explains long run economic growth. We discuss the evolution of the neoclassical school of economics in a historical context, and the role of various institutions in engendering economic growth. Subsequently, the role of government spending, political stability, property rights and special interest groups (SIG's) that affect economic growth have been discussed and how these institutions can explain different countries to grow at divergent rates and achieve various levels of wealth. The second study presents an analysis of the Chinese economic growth model post-2008 and more notably the effect of 4 Trillion Yuan stimulus in the aftermath of the Global Financial Crisis. This study looks at the Chinese financial system and the credit creation mechanism in the economy; the data shows that post-2008 there has been a sudden increase in credit outside the formal banking system. We specifically focus on the off-balance sheet Entrusted Loans provided by non-bank entities via the shadow banking system. We explain the entrusted loan mechanism and the rapid increase in Non-bank credit. Our stress tests results for the 15 major banks in China indicate that the banks remain well capitalized in the case of an idiosyncratic shock, notably the SIFI's but can experience contagion through the Interbank funding market via smaller banks. The third study sheds light on the relationship between the ratio of equity prices and current earnings per share, the Price Earning (P/E) ratio. The P/E ratio is widely considered to be an adequate gauge of under/overvaluation of a corporation?s stock. Arguably, a more reliable indicator, the Cyclically-Adjusted Price Earning ratio or CAPE, can be obtained by replacing current earnings with a measure of permanent earnings i.e. the profits that a corporation can earn, on average, over the medium to long run. In this study, we aim to understand the cross-sectional aspects of the dynamics of the valuation metrics across global stock markets including both developed and emerging markets. We use a time varying DCC model to exploit the dynamics of correlations, by introducing the notion of value spread between CAPE and the respective Market Index from 2002 to 2014 for 34 countries. We find that the Value spread is statistically significant during the 2008 crisis for asset allocation. The signal can be utilized for better asset allocation as it allows one to interpret the common movements in the stock market for under/overvaluation trends. These estimates clearly indicate periods of misevaluation in our sample. Furthermore, our simulations suggest that the model can provide early warning signs for asset mispricing in real time on a global scale and formation of asset bubbles.