Significance of Macro Economic Variables in a Stock Market: Evidence from Indian Stock Market

by

Acknowledgement

I would take this opportunity to thank my research supervisor, family and friends for their support and guidance without which this research would not have been possible.

DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University.

Signed __________________ Date _________________

Abstract

This dissertation investigates the long run and short run relationships between Indian stock market returns and eight macroeconomic variables. We investigate the ability of these variables to predict the level and volatility of Saudi stock market returns. A wide range of Vector autoregression (VAR) and generalized autoregressive conditional heteroskedasticity (GARCH) models estimated and interpreted. A Johansen-Juselius cointegration test indicates a positive long run relationship between the Incian stock price index and the M2 money supply, bank credit, and the price of oil, and a negative long run relationship with the M1 money supply, the short term interest rate, inflation, and the U.S. stock market. An estimated vector error correction model (VECM) suggests significant unidirectional short run causal relationships between Saudi stock market returns and the money supply and inflation. The VECM also finds a significant long run causal relationship among the macroeconomic variables in the system. The estimated speed of adjustment indicates that the Saudi stock market converges to the equilibrium within half a year. Granger causality tests show no causal relationship between Saudi stock market returns and the exchangerate.Table of Contents

CHAPTER 1: INTRODUCTION6

1.1 Introduction6

1.2 Problem Statement and Research Questions10

1.3 Significance of the Research12

CHAPTER 2: LITERATURE REVIEW14

2.1 Related Empirical Studies14

2.1.1 Studies Related to Developed Economies15

2.1.2 Studies Related to Developing Economies22

CHAPTER 3: MACROECONOMIC VARIABLE SELECTION AND VALIDATION24

3.1 Money Supply (M1 and M2)25

3.2 Short Term Interest Rate (MIBOR3)26

3.3 Inflation (CPI)26

3.4 Bank Credit (BC)28

3.5 World Oil Prices (BOP)28

3.6 Exchange Rate (Ex)29

3.7 Standard and Poor's 500 Index (S&P 500)29

CHAPTER 4: EMPERICAL RESULTS OF VAR MODELS31

4.1 Data Definitions31

4.2 Descriptive Statistics35

4.3 Long-Run Analysis37

4.3.1 Unit Root Test Results38

4.3.2 Selection of Optimal Lag lengths40

4.3.3 Results of the Johansen-Juselius Cointegration Test43

4.4 Short-Run Analysis50

4.4.1 Causality Tests50

4.5 Dynamic Analysis56

4.5.1 Impulse Response Function Analysis56

CHAPTER 5: EMPERICAL RESULTS OF GAARCH MODEL60

5.1 Descriptive Statistics60

5.2 Modeling the Conditional Mean Equation63

5.3 Estimated Results of the AR(1)-GARCH (1,1) Model67

5.4 Impact of Macroeconomic Volatility69

CHAPTER 6: CONCLUSION AND RECOMMENDATION74

REFERENCES80

CHAPTER 1: INTRODUCTION

1.1 Introduction

The stock market plays a vital role in the modern economy since it acts as a mediator between lenders and borrowers. That is, a well-functioning stock market may assist the development process in an economy through two important channels: boosting savings and allowing for a more efficient allocation of resources. Savings are presumed to increase as the stock market provides households with assets that may satisfy their risk preferences and liquidity needs (Leigh, 1997). Also, based upon the idea of the price mechanism, a well-functioning stock market values profitable company's shares more than those of unsuccessful ...