Review Of Macroeconomic Variables And Stock Market Indices Finance Essay

Exchange rate is defined as the monetary value of one state ‘s currency expressed in another state ‘s currency. In other words, it is the rate at which one currency can be exchanged for another. Exchange rate may be fixed or flexible. It is called a fixed exchange rate when two states agree to keep a fixed rate through the usage of pecuniary policy. On the other manus, an exchange rate is flexible, or drifting, when two states agree to allow international market forces determine the rate through demand and supply.

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Industrial Production

Industrial production is used to mensurate alterations in end product for the industrial sector of the economic system. The industrial sector includes fabrication, public-service corporations etc. It is an of import tool for calculating future GDP and economic public presentation. Industrial production are besides used by cardinal Bankss to mensurate rising prices, as high degrees of industrial production can take to uncontrolled degrees of ingestion and rapid rising prices.

2.1.2 Stock Market indices

Stock market indices are indispensable agencies of mensurating a subdivision of the stock market. As the stocks in a group alteration value, the index besides changes value. If an index goes up by 5 % , it means that the entire value of the securities which make up the index have gone up by 5 % in value.

Stock market indices are of import in the sense that if one invests in common financess or single stocks, so it is of import to mensurate the public presentation of the investing against a relevant market index. If the investings systematically lag behind the index, new investing schemes might be devised.

One of the most common indices is the Dow Jones Industrial Average which is an index of 30 “ bluish bit ” U.S. stocks of industrial companies ( excepting transit and public-service corporation companies ) .

The S & A ; P 500 Composite Stock Price Index is an index of 500 stocks from major industries in the U.S. economic system. There are indices for about every imaginable sector of the economic system and stock market.

The FTSE 100 index is a portion index of the 100 most extremely capitalized UK companies listed on the London Stock Exchange.

The Nikkei 225 is a stock market index for the Tokyo Stock Exchange. It is one of the oldest and most good known indices in the universe. Unlike the Dow Jones, the Nikkei is designed to reflect the overall market ; there is no specific weighting of the industries.

2.1.3 Relationship between macroeconomic variables and stock market

A important literature now exists which investigates the relationship between stock market and a scope of macroeconomic and fiscal variables, across a figure of different stock markets and over a scope of different clip skylines. Existing fiscal economic theory provides a figure of theoretical accounts that provide a model for the survey of this relationship.

The Arbitrage Pricing Theory

One manner of associating macroeconomic variables and stock market returns is through the Arbitrage Pricing Theory ( APT ) ( Ross, 1976 ) – a theoretical option to the Capital Asset Pricing Model ( CAPM ) .

The APT provinces that the expected return of a fiscal plus can be modeled as a additive map of assorted macroeconomic factors or theoretical market indices, where sensitiveness to alterations in each factor is represented by a factor specific beta coefficient.

Some of the macroeconomic variables important in explicating security returns, as identified by Chen, Roll and Ross ( 1986 ) are

Surprises in rising prices

Surprises in GNP as indicated by an industrial production index

Surprises in investor assurance due to alterations in default premium in corporate bonds ;

Surprise displacements in the output curve

The Dividend Discount Model

A common theoretical model linking stock monetary values to macroeconomic basicss is the dividend price reduction theoretical account.

Assuming changeless growing in dividends,

P=D1/ ( k-g ) ( 1 )

Where P= stock monetary value, D1=dividends after i¬?rst period, g= changeless growing rate of the dividends and k= required rate of return on the stock.

This theoretical account postulates that the current portion monetary value equivalents the present value of future hard currency flows, which depends on the growing of a company. As a company ‘s growing depends on domestic macroeconomic status every bit good as its major trading spouses, the co-movement of macroeconomic variables across states may act upon the comovement of stock monetary values in those states. Consequently, macroeconomic variables will impact stock monetary values if it impacts on either outlooks about future dividends, price reduction rates, or both.

The Present Value Model

An alternate, but non inconsistent, attack to explicate the relationship between macroeconomic variables and stock market is the discounted hard currency flow or present value theoretical account ( PVM ) . This theoretical account relates the stock monetary value to future expected hard currency flows and the future price reduction rate of these hard currency flows. Again, all macroeconomic factors that influence future expected hard currency flows or the price reduction rate by which these hard currency flows are discounted should hold an influence on the stock monetary value. The advantage of the PV theoretical account is that it can be used to concentrate on the long tally relationship between the stock and the macroeconomic variables.

2.2 Empirical Reappraisal

There are a figure of bing surveies that attempt to find the relationship between stock market and macroeconomic variables. Numerous surveies have focused on developed states, in more recent times, nevertheless, there has been an encouraging figure underscoring on developing economic systems.

Get downing with Chen, Roll and Ross ( 1986 ) , the writers used some macroeconomic variables to explicate stock returns in the US stock market. They used simple statements to take a set of economic province variables that, a priori, were campaigners as beginnings of systematic plus hazard. Several of these economic variables were found to be important in explicating expected stock returns, most unusually industrial production, alterations in hazard premium, and turns in the output curve. Both awaited and unforeseen rising prices rates were concluded to be negatively related to the expected stock returns.

Similar to Chen, Roll and Ross ( 1986 ) , Hamao ( 1988 ) determined whether the ascertained relationship between macroeconomic variables and portion returns were applicable when the analysis is conducted in the Nipponese market place. The latter, besides the other macroeconomic variables included by Chen, Roll and Ross ( 1986 ) , incorporated international trade variables. Except from industrial production which appeared insignificant in plus pricing Hamao ‘s findings were consistent with Chen, Roll and Ross ( 1986 ) research.

In their survey on whether current economic activities in Korea could explicate stock market returns, Kwon and Shin ( 1999 ) , concluded that Korean stock market reflects macroeconomic variables on stock market indices. The cointegration and vector mistake rectification theoretical account illustrate that stock monetary value indices are cointegrated with a set of macroeconomic variables-that is the production index, exchange rate, trade balance and money supply-which provides a direct long tally equilibrium relation with each stock monetary value index. However, they concluded that the stock monetary value indices are non a prima index for economic variables.

Nasseh and Strauss ( 2000 ) happen support for the being of important long run relationships between stock market monetary values and domestic and international economic activity in six states which included France, Italy, Switzerland, Germany, Netherlands and the U.K. Johansen ‘s cointegration trials confirmed that stock monetary value degrees were significantly related to industrial production, concern of fabricating orders, short- and long-run involvement rates every bit good as foreign stock monetary values, short-run involvement rates, and production. Nasseh and Strauss ( 2000 ) besides used discrepancy decomposition methods that supported the strong explanatory power of macroeconomic variables in lending to the prognosis discrepancy of stock market monetary values. They recognized the utility of Johansen ‘s model for analysing stock market and macroeconomic activity-it incorporates dynamic co-movements or coincident interactions, leting the research workers to analyze the channels through which macroeconomic variables affected plus pricing, every bit good as their comparative importance. Their discrepancy decomposition methods, based on a vector car arrested development with extraneous remainders, showed that macroeconomic factors explained a significant portion of the fluctuation in stock monetary values in the medium and short tallies. Nasseh and Strauss ( 2000 ) found that although stock monetary values were explained by economic basicss in the medium and short-run, the underlying volatility inherent in stock monetary values was related to macroeconomic motions in the long tally.

McMillan ( 2001 ) , utilizing US informations, undertook to look into whether a cointegrating vector existed between variables such as industrial production, rising prices, money supply, involvement rate and stock market indices. The findings provided positive support of cointegration between both the US market index Dow Jones Industrial Average index ( DJIA ) and the S & A ; P 500 and macroeconomic activity variables. The established relationship is positive and important for industrial production and rising prices, negative and important for long term involvement rates, and negative and undistinguished for money supply and short term involvements rates. The consequences are consistent with the belief that changes in end product which affect expected future hard currency flows have a positive consequence on stock monetary values, that stocks act as an rising prices hedge and that alterations in the price reduction rate have an reverse consequence on monetary values. In add-on, discrepancy decompositions show that long-run rates explain a significant sum of variableness in stock monetary values, whilst short-run rates, industrial production and rising prices besides have some explanatory power.

Maysami and Sims ( 2002, 2001a, 2001b ) employed the Error Correction Modeling technique to analyze the relationship between macroeconomic variables and stock returns in Hong Kong and Singapore ( Maysami and Sims 2001b ) , Malaysia and Thailand ( Maysami and Sims 2001a ) , and Japan and Korea ( Maysami and Sims 2001b ) . Through the employment of Hendry ‘s attack which allows doing illations to the short tally relationship between macroeconomic variables every bit good as the long tally accommodation to equilibrium, they analysed the influence of involvement rate, money supply, existent activity, rising prices and exchange rate, along with a silent person variable to capture the impact of the 1997 Asiatic fiscal crisis. The consequences confirmed the influence of macroeconomic variables on the stock market indices in each of the six states under survey, though the type and magnitude of the associations differed depending on the state ‘s fiscal construction.

Wongbangpo and Sharma ( 2002 ) explored the relationship between the stock returns for the ASEAN-5 states of Indonesia, Malaysia, the Philippines, Singapore, and Thailand and five macroeconomic variables. By detecting both short and long tally relationships between several stock indexes and the macroeconomic variables of gross national merchandise ( GNP ) , the consumer monetary value index ( CPI ) , the money supply, the involvement rate, and exchange rate they found that in the long-term all five stock monetary value indexes were positively related to growing in end product and negatively to the aggregative monetary value degree. However, a negative long-term relationship between stock monetary values and involvement rates was noted for the Philippines, Singapore, and Thailand, and was found to be positive for Indonesia and Malaysia. In the terminal, causality trials detected an overall relationship between macroeconomic variables and stock monetary values for all five ASEAN equity markets

Chakravarty ( 2005 ) made an effort to analyze the causal relationship between macroeconomic variables and stock monetary value for India for the period of April 1991 to December 2005 utilizing Granger causality trials. The consequences obtained consistent causality consequences for some back-to-back slowdown constructions along with the optimum pick of the slowdown utilizing Akaike information standards ( AIC ) and Schwartz standard ( SC ) , so the consequences are robust. The nine empirical consequences suggested that exchange rate does non Granger do stock monetary value nor stock monetary value Granger cause exchange rate. Furthermore, the empirical consequences further suggested that the index of industrial production and the rate of rising prices Granger do the behavior of stock monetary value but does non Granger do index of industrial production and rising prices, so the causing is unidirectional. In add-on, the causal relation between the behavior of stock monetary value and M3 is unidirectional, the behavior of stock monetary value doing M3. Gold monetary value which is included in the theoretical account does non demo any relationship with stock monetary value.

Gay ( 2008 ) investigates the clip series relationship between stock market index monetary values and the macroeconomic variables of exchange rate and oil monetary value for Brazil, Russia, Indian and China utilizing the Box Jenkins ARIMA theoretical account. No important relationship was found between several exchange rate and oil monetary value on the stock market index monetary values of either country. , this may be due to the influence other domestic and international macroeconomic factors on stock market returns as explained by the writer. In add-on, no important relationship was found between present and past stock market returns, proposing the markets of Brazil, Russia, India and China exhibit the weak signifier of market efficiency.

Mahmood and Dinniah ( 2009 ) examine the kineticss relationship between stock monetary values and economic variables in six Asiatic Pacific selected states of Malaysia, Korea, Thailand, Hong Kong, Japan and Australia. The monthly informations on stock monetary value indices, foreign exchange rates, consumer monetary value index and industrial production index that spans from January 1993 to December 2002 are used. The focal point of the analysis is on the long tally equilibrium and short tally multivariate causality between these variables. The consequences indicated the being of a long tally equilibrium relationship between and among variables in merely four states that is Japan, Korea, Hong Kong and Australia. As concerned short tally relationships, all states except for Hong Kong and Thailand showed some interactions. Hong Kong shows relationship merely between exchange rate and stock monetary value while Thailand reported important interaction merely between end product and stock monetary values.

The tabular array below summarises the empirical research conducted by assorted writers in different states under different clip skylines. It besides summarises the findings.

Name of Author ( s )

State under study/Period

Methodology

Findingss

Mukherjee and Naka ( 1995 )

Tokyo-January 1971 to December 1990

Johansen ‘s VECM

A cointegrating relationship exists and that stock monetary values contribute to this relation.

Cheung and Ng ( 1998 )

Canada, Germany, Italy, Japan, US

Johansen Cointegration techniques

Evidence of long tally co-movements between five national stock market indexes and steps of aggregative existent activity

Ibrahim ( 1999 )

Kuala Lampur

Detecting that macroeconomic variables led the Malayan stock indices, he concluded that the market topographic point was informationally inefficient.

Islam ( 2003 )

Kuala Lampur

Hendry ‘s attack

Statistically important short tally and long tally relationships between index and variables under survey.

Omran ( 2003 )

United arab republic

Cointegration analysis through Error Correction Mechanism

Long tally and short tally relationships between the variables.

Vuyyuri ( 2005 )

India/1992-2002 ( monthly observations )

Cointegration and Causality trials

Cointegration trial supported the long tally equilibrium relationship between fiscal and the existent sector, and the farmer causality between the fiscal sector and the existent sector of the economic system

Maghyereh ( 2002 )

Jordan

Cointegration analysis

Macroeconomic variables were reflected in stock monetary values.

Islam and Watanapalachaikul ( 2003 )

Siam

Cointegration analysis

Strong, important long tally relationship between stock monetary values and macroeconomic factors

Christopher G, Minsoo L, Hua H, Jun. Z ( 2006 )

New Zealand

Cointegration analysis

No grounds that the New Zealand Stock Index is a prima index for alterations in macroeconomic variables.

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