International Journal of Finance and Policy Analysis 5 (1): Spring 2013 3 FOREIGN DIRECT INVESTMENT AND STOCK MARKET DEVELOPMENT: EVIDENCE FROM GHANA I. K Acheampong Department of Economics, University of Cape Coast, Cape Coast, Ghana E-mail: ikacheampong@yahoo.co.uk E. A. Wiafe Research Student, Department of Economics, University of Cape Coast, Cape coast, Ghana E-mail: nwaric@ymail.com/emmacademics@gmail.com Abstract: The paper examined the impact of Foreign Direct Investment (FDI) on stock market development. In this regard, the paper examined the complementary hypothesis vis-à-vis the substitutability hypothesis. Using ARDL model and quarterly time series data from International Financial Statistics and Bank of Ghana from 1990 to 2010, it was found that the complementary hypothesis was vindicated. FDI had positive impact on stock market development and this supported the complementary hypothesis in the short run. In addition, Inflation and Exchange rate had positive impact on stock market development. Also there was a bi-causality between FDI and stock market development. The policy implications are that government could maintenance of prudent macroeconomic policies and continue to create legal and congenial environment to stimulate the flow of foreign direct investment and encourage the re-investment of surpluses so that stock market development and economic growth could be enhanced. In other to attract FDI on sustainable bases, stock market development needs to be enhanced. INTRODUCTION Many developing countries now have stock markets in their respective countries. Financial markets, and in particular stock markets, have grown considerably in developing countries including Ghana over the last two decades. This is due, in part, to globalization which has also promoted better links among financial markets and greater participation of foreign financial firms around the world (Claessens, Klingebiel, and Schmukler 2001). Developing countries have had better macroeconomic management, which has brought to the fore better macroeconomic fundamentals (higher economic growth, low inflation, stable exchange rate) Yartey and Adjasi (2007). In addition, the implementation of stabilisation and structural adjustment programmes put in place better policies (notably privatization of state-owned enterprises), and specific policy changes (notably domestic financial sector reforms and capital account liberalization) which have in no doubt contributed to better economic growth and development. The IMF and the World Bank supported developing countries with loans for good policy changes with conditionalities in the 1980s. These reforms created a congenial atmosphere for the flow of capital from developed to most developing countries. Over the last two decades, a large number of developing countries have implemented significant capital market reforms, which included stock market liberalisation, improvements in securities clearance and settlements systems, and the development of regulatory and supervisory framework. These reforms, together with improved macroeconomic management and related reforms, such as the privatization of state- owned enterprises and the shift to privately managed defined contribution pension systems, were expected to foster domestic financial development. The successful implementation of these reforms, coupled with good and quality institutions backed by good legal framework have fostered the development of financial and stock markets (Collier, Hoeffler, and Pattillo, 2000). In Ghana, for example, the Economic Recovery Programme was implemented from 1983 to 1992 and it comprised stabilisation phase (1983-86), rehabilitation phase (1986-88) and growth and