Stock Market And Macroeconomic Variables In India

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ABSTRACT

The present paper is aimed at studying the nature of the causal relationship between stock prices and macroeconomic aggregates in India, if any. By applying the techniques of unit–root tests, cointegration and the Granger test the causal relationships between the NSE Index ‘Nifty’ and the macroeconomic variables, viz., Real effective economic rate (REER), Foreign Exchange Reserve (FER), and Balance of Trade (BoT), Foreign Direct Investment (FDI), Index of industrial production (IIP), Wholesale price index (WPI) using monthly data for the period 1st April 2006 to 31st March 2010 have been studied.

The major findings of the study are (i) there is no cointegration between Nifty and all other variables except Wholesale price index (WPI) as per Johansen Cointegration test. Therefore causal relationship between such macro economic variables having no cointegration with nifty is not established. (ii) Nifty does not Granger Cause WPI and WPI also does not Granger Cause Nifty.

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Key Words: Granger Causality, Macroeconomic Variables, Cointegration, Stock Prices

JEL Classification: G1, E4

Introduction

The movement of stock indices is highly disposed to the changes in rudiments of the economy and to the changes in future prospects expectations. These expectations are influenced by the micro and macro fundamentals which may be formed either logically or adaptively on economic fundamentals, as well as by many subjective factors which are unpredictable and also non quantifiable. It is believed that domestic economic fundamentals play seminal role in the performance of stock market. However, in the era of globalisation and integration of world economies, domestic economic variables are also subject to change due to the policies adopted and expected to be adopted by other countries or some global events. The common external factors influencing the stock return are stock prices in global economy, the interest rate, foreign investment and the exchange rate. For illustration, capital inflows and outflows are not determined by domestic interest rate alone but also by the changes in the interest rate by major economies in the world. Recently, it is experienced that contagion from the US sub prime crisis has played significant movement in the capital markets across the world as foreign hedge funds unwind their positions in various markets. Other burning example in India is the appreciation of Indian currency due to increased inflow of foreign exchange. It has resulted in a decline in the stock prices of major export oriented companies especially in Information technology and textile sectors. The modern financial theory concentrates upon systematic factors as sources of risk and contemplates that the long run return on an individual asset must replicate the changes in such systematic factors. This implies that securities market has an important relationship with real and financial sectors of the economy. This relationship is generally viewed in two ways.

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