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I J A B E R, Vol. 14, No. 14 (2016): 167-196

IMPACT OF MACROECONOMIC VARIABLES ON STOCK

MARKET: A REVIEW OF LITERATURE

Herpreet Kaur*, Dr. Jagdeep Singh** and Nitu Gupta***

Abstract: A large attention is being paid on various factors which impact stock market. Despite
the growing literature on impact of variable on stock market, little effort has been done devoted to
synthesize the overall state of art on the topic. In this paper, an attempt is being made to review the
status of literature on impact of macroeconomic variables on stock market, thus to find research
gap. A literature review scheme is presented. A total of 190 published articles 1961 to 2014 are
reviewed. Based on review, suggestion for further research is likewise provided.
Keywords: Macroeconomic variables, Literature review, Stock market.

1. INTRODUCTION
Probably the relationship between stock prices and macroeconomic variables is
well illustrated by the Dividend Discount Model (DDM) proposed by Miller and
Modigliani (1961) than any other theoretical stock valuation model. According to
the model the current price of an equity share equals the present value of all future
cash flows to the share. Thus, the determinants of share prices are the required rate
of return and expected cash flows (see Oyama, 1997; Gan et al 2006) suggesting that
economic factors that influence the expected future cash flow and required rate of
return affect the share price. Macroeconomic factors are significant and fundamental
determinants over the long investment horizon, because, as expressed by King (1966),
share prices are subject to the impact of macroeconomic factors by an average of 50%.
Large number of researches is done, to study the impact of economic variables
on stock prices. This paper provides the overview of researches done and will serve
as a roadmap of literature for academicians and practitioners to help stimulate
further interest.

2. REVIEW OF LITERATURE
Fama investigated the relationship between eco­nomic activities and stock returns(US)
and concluded that there are positive relationships between stock returns and GNP,
* Research Scholar, IK Gujral Punjab Technical University, Kapurthala Punjab
** Professor, Bhattal Institute of Management, Mohali
*** Research Scholar, Veer Narmad South Gujarat University
168  l  ??????

money supply, capital expenditure, indus­trial production, and the interest rate but
a negative re­lationship between stock returns and the inflation rate (Fama, 1981).
Geske and Roll (1983) also show that economic activity proxied by industrial
output has a positive impact on stock prices through its effect on expected future
cash flows.
Ta and Teo (1985) had earlier observed high correlation among six Singapore
sector indices in the period 1975 to 1984 and the overall SES market return (e.g. All-S
Equities Industrial and Commercial Index, SES All-S Equities Finance Index, SES
All-S Equities Property Index, SES All-S Hotel Index, SES All-S Plantation Index
and SES All-S Mining Index). Using daily data in examining the relationships, they
had concluded that sector returns were highly correlated to each other, although
such correlations did not remain stable over time.
Chen et al., (1986) used the APT model to link stock market returns in the
United States (US) to a linear function of various macro-economic factors. They
contended that economic forces affect the discount rate, firms’ respective cash
flows, and future dividend payouts. They found strong correlations be­tween the
selected macroeconomic variables and US stock market returns and concluded that
industrial production, changes in the risk premium, and twists in the yield curve
were the most significant factors in explaining US stock returns.
Whilst Aggarwal (1981) finds a positive relationship between stock price
movements and exchange rate movement in the US, Soenen and Hennigar (1988)
detect a negative relationship.
Aidoo (1989) also reported several factors such as political instability, low-
growth rate, lack of entrepreneurship and inadequate demand for stocks as some
of the factors that are likely to influence the performance of the GSE. The study
projected massive growth of the exchange in terms of demand and supply provided
the economic and political conditions remained favorable.
Martinez and Rubio (1989) tested the Spanish market return and they found
that there were no significant pricing relationship between stock returns and the
macroeconomic variables. Moreover, they found that the multifactor APT with
macroeconomic variables fails to explain the size effect in Spanish stock returns.
Fung and Lee(1990) studied the long term relationships between stock return
on the one hand and GNP, inflation and money supply on the other in Taiwan and
concluded that the efficient market hypothesis is not valid for an emerging market.
For Poon and Taylor (1991), the economic variables which are used in this study
include monthly and annual growth rate of industrial production, unanticipated
inflation, risk premium, term structure of return on value weighted market index.
To incorporate potential lead/lay relationships, the procedure carried out for each
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  169

of the market indicates the macroeconomic factors in this study. They showed that
the tested macroeconomic variables do not affect the share price in the UK stock
market.
Paddy (1992) contends that macroeconomic and fiscal environment is one of
the building blocks which determine the success or otherwise of securities market.
Conducive macroeconomic environment promotes the profitability of business
which propels them to a stage where they can access securities for sustained growth.
Generally, the barometers for measuring the performance of the economy include
among others real GDP growth rate, rate of inflation, the exchange rate, fiscal
position and the debt position.
Bahmani and Payesteh (1993) conclude that there exists a bi-directional causality
between stock prices and exchange rate, at least in the short-run, although the
cointegration analysis does not depict any long-term relationship between these
variables.
Fang and Loo (1994) studied the relationship between stock return volatility
and international trade for four Asian countries. They however, found evidence
in favor of the efficient market hypothesis. Their empirical results based on vector
autoregressive model(VAR) suggested that the stock return volatility in the four
markets respond to information on trade.
Hardouvelis, has and et al., analyze a long-run relationship between concluded
that the reaction of stock price to interest rate stock and gold prices, also oil price
and currency rate in changes would be negative using American Central Bank
Taiwan. They suggested that the long-run relationship discount rate as a proxy of
interest rate.
Sun and Brannman (1994) similarly found a single long-run relationship among
the SES All-S Equities Industrial & Commercial Index, Finance Index, Hotel Index,
and Property Index from 1975 to 1992. The current study builds upon and extends
the literature through the employment of Johansen’s (1988) VECM to examine the
long run equilibrium relationship between selected macroeconomic variables and
stock market sector indices represented on the Stock Exchange of Singapore (recently
demutualized and renamed the Singapore Exchange (SGX)): the Finance Index, the
Property Index, and the Hotel Index. The choice of macroeconomic variables and
the hypothesized relations with the sector indices are discussed next.
The impact of 18 selected macroeconomic factors on the stock market in Great
Britain was investigated e.g. by Clare and Thomas (1994) who came to the conclusion
that there is strong correlation between the yield of the local stock market and oil
price, inflation and the volume of bank loans.
Barrows and Naka (1994) investigated how selected macroeconomic variables
influence restaurant and hotel stock returns in the USA over a 27-year period. The
170  l  ??????

results suggest that the direction of macroeconomic forces is consistent across the
industrial, lodging and restaurant sectors although differences in significance do
occur. Barrows and Naka’s study found that macroeconomic variables are able to
explain the movement of restaurant stock returns to a greater extent than either
the lodging or industrial sectors. The major limitation of this study is that it did not
examine the time series properties of the variables before using regression analysis.
The results of regression analysis are only valid when all the variables are integrated
of the same order.
Mukherjee and Naka (1995), with the use of Johansen’s (1998) VECM the authors
analyzed the relationship between the Japanese Stock Market and exchange rate,
inflation, money supply, real economic activity, long-term government bond rate,
and call money rate. They concluded that a cointegrating relation indeed existed
and that stock prices contributed to this relation.
Using data from 1976 to 1993 on 41 countries including both developed and
developing, Levine and Zervos (1996a, b) investigated the relationship between
economic growth and stock market development. They found a strong positive
correlation between the stock market development and long-run economic growth
after controlling for the initial level of per capita GDP, initial level of investment in
human capital, political instability and measures of fiscal and monetary policies as
well as exchange rate policy.
Ajayi and Mogoue (1996) establish a long-run relationship using eight
industrialized countries and conclude that currency depreciation leads to negative
effects on stock prices.
It is argued that there is an inverse relationship between interest rates and stock
returns. Thorbecke (1997) and Smal and de Jager (2001) observe that a reduction in
interest rates induces an injection of liquidity into the economy. This extra liquidity
could be channeled to the stock market, driving up the demand and prices of stocks.
Patelis (1997) notes that interest rate changes are helpful in predicting stock market
returns over a long period. Thus, there is evidence to conclude that interest rate
policies should also target stock market price movements.
Mookerjee and Yu (1997) examined the nexus between Singapore stock returns
and four macroeconomic variables such as narrow money supply, broad money
supply, exchange rates and foreign exchange reserves using monthly data from
October 1984 to April 1993. Their analysis revealed that both narrow and broad
money supply and foreign exchange reserves exhibited a long run relationship with
stock prices whereas exchange rates did not.
Goswami and Jung (1997) in their study on the effects of economic factors on
Korean stock market employed the VECM to verify the SR and LR relationship
between stock price and nine macroeconomic variables namely; SR-IR, LR-IR,
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  171

Inflation, money supply, industrial production, oil price, balance of trade for current
account and foreign exchange from two different currencies i.e. Korean won per
USD and Korean won per Japanese Yen. The authors conclude that the Korean Stock
prices are positively related to industrial production, inflation and SR interest rate
Applying two-stage least squares, Harris (1997) did find evidence to support
the view that stock market development explains economic growth. In fact, the
results indicated that for developed countries stock market development had
some explanatory power on economic growth but not on developing countries.
He concluded that the pool of literature that leads us to believe that the existence
of stock markets might enhance economic growth is misleading or at best weak.
Ajayi et al. (1998) also show that causality runs from stock returns to movements
in the exchange rates in the case of advanced markets whilst there is no significant
causality either way for emerging markets.
Cheung, Ng (1998) have also confirmed positive correlation between oil prices,
the money supply and GDP in Germany, Italy and Japan.
Zhao (1999) studied the relationships between stock prices in the Chinese
financial market by considering inflation and the industrial produc­tion index
from 1993 to 1998. The results indicate that both inflation and expected growth in
industrial output have negative relationships with the stock mar­ket.
Bernanke and Gertler (1999, 2001) observe that the volatile nature of asset
prices makes them hard to predict and that monetary authorities should only
change interest rates in reaction to stock-price movements, when they expect such
movements to affect inflation. Moreover, the credibility of interest rate policy may
reduce, if interest rates change rapidly in response to asset price movements.
Kwanchanok (2000) investigated the relationships between Thai­land’s stock
market indices (SETI) and the following macroeconomic variables: inflation rate,
interest Rate, GDP, current account balance, money supply, securi­ties trading
volume, securities trading value, the value of the Thai Baht, and the currency
exchange system. Kwanchanok (2000) employed monthly data from January 1994
to December 1999 and found that the in­flation rate, money supply, securities
trading volume, securities trading value and the currency exchange rate system
have positive effects on the Thai stock market, whereas the interest rate and GDP
have negative ef­fects.
In Africa, Jefferis and Okeahalam (2000) examine the effect of macroeconomic
factors on stock markets in South Africa, Zimbabwe, and Botswana. They find that
stock prices have a positive long-run relationship with real GDP, and real exchange
rate in South Africa and Zimbabwe and a short-run relationship with exchange rate
and interest rates in Botswana. Stock prices are also negatively related to interest
rates in South Africa.
172  l  ??????

Banny and Enlaw (2000) also unearthed the relationship between the exchange
rate of the Malaysian Ringgit in terms of the USD and stock prices in Kuala Lumpur
Stock Exchange (KLSE) through the application of single and multi-index models.
Their conclusion was that a negative relationship exists between exchange rate and
KLSE stock prices.
Muhammad and Rasheed (2002) also find mixed cointegration results amongst
four Asian countries.
Islam (2003) replicated the above studies to examine the short-run dynamic
adjustment and the long-run equilibrium relationships between four macroeconomic
variables (interest rate, inflation rate, exchange rate, and the industrial productivity)
and the Kuala Lumpur Stock Exchange (KLSE) Composite Index. His conclusions
were similar: there existed statistically significant short-run (dynamic) and long-
run (equilibrium) relationships among the macroeconomic variables and the KLSE
stock returns.
Hassan (2003) employed Johansen’s (1988, 1991, 1992b) and Johansen and
Juselius’ (1990) multivariate cointegration techniques to test for the existence of long-
term relationships between share prices in the Persian Gulf region. By employing
vector-error-correction model, his study also investigated the short-term dynamics of
prices by testing for the existence and direction of intertemporal Granger-causality.
The analyses of weekly price indices in Kuwait, Bahrain, and Oman stock markets
showed that: (1) share prices were cointegrated with one cointegrating vector and
two common stochastic trends driving the series, which indicates the existence of
a stable, long-term equilibrium relationship between them; and (2) prices were not
affected by short-term changes but were moving along the trend values of each
other. Therefore, information on the price levels would be helpful for predicting
their changes.
Taghavi and Janani, studied the effect of macroeconomic variables on stock price
index over 1990-1998. For this purpose, cointegration and vector auto regression
methods have been used. The results indicate that there is a fragile relationship
among all independent (macroeconomic variables) and the dependent variable
(stock price index).Taghavi and Mohammadzadeh, stated that there is a positive
relationship between stock price index and both house price and exchange rate,
but negative relationship between money between the index and money supply,
private sector investment and oil price.
Gjerde and Sættem (1999) examined the causal relations among stock returns and
macroeconomic variables in Norway. Their main focus was on the extent to which
important results on relations among stock returns and macroeconomic factors from
major markets are valid in Norway. Using multivariate vector autoregressive (VAR)
approach they were able to establish several significant links. Their findings were
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  173

consistent with both US and Japanese findings. That is, real interest rate changes
affect both stock returns and inflation, and the stock market responds accurately
to oil price changes. They further found a delayed response of the stock market to
changes in domestic real activity.
Sadorsky (1999) investigated the dynamic interaction between oil price and
other economic variables including stock returns using an unrestricted vector
auto-regression (VAR) with US data. The study found that oil price changes and
oil price volatility have a significantly negative impact on real stock returns. The
study also found that industrial production and interest rates responded positively
to real stock returns shocks. Sadorsky, however, found that in periods subsequent
to 1986, oil price shocks have significant effect on real stock returns. Above all, the
study showed that oil price movements explain a larger portion of the forecast error
variance in real stock returns than interest rates.
Ibrahim (1999 and 2003) investigated the dynamic interactions between the
KLSE Composite Index and seven macroeconomic variables (industrial production
index, money supply M1 and M2, consumer price index, foreign reserves, credit
aggregates and exchange rate). The result of his studies provided evidence that
Malaysian stock market was informational inefficient.
Granger et al. (2000) find no evidence of cointegration between stock prices and
exchange rate for a group of Asian countries. However, the study finds significant
short-run feedback effects using Granger causality tests and impulse response
functional analysis.
Park and Ratti (2000) found that contractionary monetary policy shocks generate
statistically significant movements in the USA inflation and expected real stock
returns, and that these movements go in opposite directions. Since positive shocks
to output precipitate monetary tightening, they argue that the countercyclical
monetary policy process is important in explaining the negative correlation between
inflation and stock returns. They report that monetary policy tightens significantly
in response to positive shocks to inflation, and that the impact of monetary policy
shocks on stock returns is negative and volatile. Their results provide evidence for
the existence of an “anticipated policy” hypothesis.
Maysami and Koh (2000) examined such relationships in Singapore. They found
that inflation, money supply growth, changes in short- and long-term interest rate
and variations in exchange rate formed a cointegrating relation with changes in
Singapore’s stock market levels.
Papapetrou (2001) studied the dynamic relationship among the oil price,
real stock prices, interest rates, real economic activity andemploymentwith data
fromGreece. The study found that an oil price shock has an immediate negative
impact on the stock market as well as industrial production and employment. That
174  l  ??????

is, a positive oil price shock depresses real stock returns. However, contrary to the
literature, Papapetrou showed that stock returns do not rationally signal (or lead)
changes in real activity and employment in his analysis since growth in industrial
production and employment respond negatively to real stock returns.
Chaudhuri and Koo(2001) investigated the volatility of stock returns in some
Asian emerging markets in terms of the volatility of domestic and external factors,
found that both domestic macroeconomic variables and international variables
have significant impact on stock return volatility. Their empirical results suggest
the presence of a significant contagion effect and integration of capital market in
this region. The results also suggested the role of government in terms of fiscal and
monetary policy in smooth functioning of the stock market is crucial in this region.
Maysami and Sims (2002, 2001a, 2001b) employed the Error-Correction
Modelling technique to examine the relationship between macroeconomic variables
and stock returns in Hong Kong and Singapore (Maysami and Sim, 2002b), Malaysia
and Thailand (Maysami and Sim 2001a), and Japan and Korea (Maysami and Sim
2001b). Through the employment of Hendry’s (1986) approach which allows making
inferences to the short-run relationship between macroeconomic variables as well
as the long-run adjustment to equilibrium, they analysed the influence of interest
rate, inflation, money supply, exchange rate and real activity, along with a dummy
variable to capture the impact of the 1997 Asian financial crisis. The results confirmed
the influence of macroeconomic variables on the stock market indices in each of
the six countries under study, though the type and magnitude of the associations
differed depending on the country’s financial structure.
Flannery and Protopapadakis (2002) studied the re­lationships between US
stock prices and economic announcements on a daily basis from 1980 to 1996
us­ing the Consumer Price Index, Producer Price Index (PPI), money supply,
the unemployment rate and the interest rate as economic factors. The findings
dem­onstrated that economic announcements significantly increase stock market
volatility, which affects stock returns. Moreover, because the CPI and PPI are mea­
sures of inflation, announcements of increases in these variables tend to depress
the stock market. Similarly, because increases in the money supply lead to inflation
and thus cause interest rates to increase, announce­ments of increases in the money
supply also tend to decrease stock prices.
Wongbangpo and Sharma explored the relationship between the stock returns
for the ASEAN-5 countries of Indonesia, Malaysia, the Philippines, Singapore, and
Thailand and five macroeconomic variables. By observing both short and long run
relationships between respective stock indexes and the macroeconomic variables of
gross national product (GNP), the consumer price index (CPI), the money supply,
the interest rate, and exchange rate they found that in the long-run all five stock
price indexes were positively related to growth in output and negatively to the
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  175

aggregate price level. But a negative long-run relationship between stock prices
and interest rates was noted for the Philippines, Singapore, and Thailand, and was
found to be positive for Indonesia and Malaysia.
Goodhart, Mahadeva, and Spicer’s (2003) research into the effect of monetary
policy changes on asset prices in the foreign exchange and equity markets, which
attributed failure to find monetary policy effectiveness during a crisis to policy
failure and the risk premia in the financial markets of Brazil and Korea.
Islam and Watanapalachaikul (2003) showed a strong, significant long-run
relationship between stock prices and macroeconomic factors (interest rate, bonds
price, foreign exchange rate, price-earning ratio, market capitalization, and consumer
price index) during 1992-2001 in Thailand.
Similarly, Kimura, Kurozumi (2003) could not find any causal correlation
between the money supply and development of the Japanese stock market. Positive
correlation between share prices and trade balance, money supply, foreign exchange
rates and industrial production was found by Chung and Shin (1999).
Gunasekarage, Pisedtasalasai and Power (2004) examined the influence of
macroeconomic variables on stock market equity values in Sri Lanka, using the
Colombo All Share price index to represent the stock market and (1) the money
supply, (2) the treasury bill rate (as a measure of interest rates), (3) the consumer
price index (as a measure of inflation), and (4) the exchange rate as macroeconomic
variables. With monthly data for the 17-year period from January 1985 to December
2001 and using unit root tests, cointegration, and VECM, they examined both
long-run and short-run relationships between the stock market index and the
economic variables The VECM analysis provided support for the argument that the
lagged values of macroeconomic variables such as the consumer price index, the
money supply and the Treasury bill rate have a significant influence on the stock
market.
Seehalak (2004) examined the co-movements be­tween the Stock Exchange of
Thailand (SETI) and the Nikkei and Dow Jones indices over the period 1994- 2003
and used the Granger causality test to identify the long-run relationships between
them. The findings suggested that the Nikkei index influences SET move­ments
over the long run whereas the Dow Jones index influences SET movements in the
short run.
Nishat and Shaheen studied the long-run equilib­rium relationship between
selected macroeconomic variables and the Pakistani (Karachi) Stock Exchange
Index and found two long-term equilibrium relation­ships among these variables.
Specifically, their results indicated that industrial production is the largest pos­itive
determinant of stock prices in Pakistan and that inflation is the largest negative
determinant.
176  l  ??????

Maysami, Howe and Hamzah (2004) determined that although the long-term
equilibrium relationships between the Singapore stock index and selected mac­
roeconomic variables are not cointegrated, the Singa­pore stock index was sensitive
to interest and exchange rates.
Bose and Coondoo (2004) suggest that there exists mild evidence of bi-directional
causality between index returns and FII net inflows, they at the same time cautioned
that it might be due to heightened foreign equity inflows caused by an upsurge in
global equity markets.
Al-Sharkas (2004) utilized the vector error correction model (VECM) to deter­
mine the impact of selected macroeconomic variables (i.e., money supply, the
interest rate and inflation) on the Amman Stock Exchange (ASE). The empirical
re­sults showed that stock prices and the selected mac­roeconomic variables have
a long-term equilibrium relationship, and that money supply and the indus­trial
production index each has a positive relationship with stock prices, whereas the
consumer price index has a negative relationship with stock prices.
According to Oberuc (2004), the economic factors which, usually associated with
stock prices movement and being considered greatly by researchers are dividend
yield, industrial production, interest rate, term spread, default spread, inflation,
exchange rates, money supply, GNP or GDP and previous stock returns, among
others.
Sardar, Watanapalachaikul and Billington (2004) explored the long-run rela-
tionship between the Thai stock market and macroeconomic factors between 1992
and 2001 using the unit root test, augmented Dickey-Fuller test, augmented Engle-
Granger test, and cointegration method. Their results showed that stock prices are
pos­itively affected by the interest rate, foreign exchange rate, price-earnings ratio,
and market capitalization over the long run, whereas bond prices and the con­sumer
price index (CPI) produced negative long-run effects.
Erdem et al. (2005) find mixed results for the Istanbul Exchange in Turkey; they
find that interest rates and inflation volatility affect stock returns volatility whilst
industrial output volatility does not affect stock returns.
When time series data from January, 1982 to December, 2002 on selected
macroeconomic variables of major stock indices of United States and Singapore were
used to examine the long–run equilibrium relationship between the two countries,
Wong et al. (2005) discovered through a cointegration test that Singapore’s stock
prices generally display a long-run equilibrium relationship with interest rate and
money supply but similar relationship does not exist in the US market.
Tri (2005) evaluated the impact of Gross Domestic Product (GDP) on Thai
stock market movements on a quarterly basis from 1996 to 2004. Unit root tests,
cointegration, the error correction mechanism (EC), and causality tests indi­cated
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  177

a long-run relationship between the variables, implying that GDP has an impact
on Thai stock mar­ket movements. The causality test also confirmed that GDP is a
Granger cause of Thai stock market move­ments with no reverse causality.
Chancharoenchai et al. (2005) investigated the relationship between domestic
macroeconomic variables and stock excess returns to evaluate the effects of
macroeconomic variables on excess returns and assess market efficiency in the
Southeast Asian economies prior to the 1997 Asian crisis. Using a battery of tests,
monthly stock excess returns are best specified by autoregressive (AR) conditional
heteroskedasticity type models. While the null hypothesis of a martingale process
is rejected, and some macroeconomic variables are identified that seem to have a
certain predictive power for excess returns. Further, they report that Asian monetary
authorities seem to have had a credibility problem in keeping inflation within a
target range which has contributed to the 1997 crisis.
Basher and Sadorsky’s (2006) exploration of the impact of oil price changes on
the stock market returns of 21 emerging economies found strong evidence of the
effect of oil prices being positive and statistically significant at the 10% level to stock
market returns for most of the countries studied.
Gan, Lee, Yong and Zhang (2006) have examined the macroeconomics variables
and stock market interaction: New Zealand Evidence. Their studied had a set of
seven macroeconomic variables and used co-integration tests, johansen maximum
likelihood and granger-causality tests. In addition, their paper also investigated the
short run dynamic linkages between NZSE40 and macroeconomic variables using
innovation accounting analyses. In general analysis it was found that the NZSE40 is
consistently determined by the interest rate, money supply and real GDP but there
is no evidence that the New Zealand Stock Index is a leading indicator for changes
in macroeconomic variables.
Menike (2006) studied impact of macroeconomic variables on stock price in
emerging Sri Lankan Stock Market. The data selected from 1991 to 2002 in which
they used Multivariate regression on all variables for each stock. The study also
finds out that there exists association between macroeconomic variables and stock
price in the Colombo Stock Exchange. Exchange rate and inflation rate respond
negatively on stock price in Colombo Stock Exchange.
Samy, Samir and Mohamed (2007) investigate the determinants of stock market
development in the Middle-Eastern and North African region using Random effects
specifications. The results shows that savings rate, financial intermediary, stock
market liquidity and the stabilization variable are the important determinants of
stock market development.
On the emerging market in Pakistan, Akmal (2007) applied the ARDL model to
reveal the impact of inflation, industrial production, money supply, interest rates
178  l  ??????

and oil price on the development of the KSE index between 1971 and 2006. The same
conclusion was reached by Husain, Mahmood (1999), in a co-integration test. They
revealed strong correlation between share prices and money aggregates M1 and M2.
Causality between money supply and share prices on emerging markets was
also investigated by Brahmasrene and Jiranyakul (2007) who focused on the Thai
stock market from 1992 to 2003 and found positive correlation between the money
supply and share prices.
Ratanapakorn and Sharma (2007) examined the short-run and long run
relationship between the US stock price index and macroeconomic variables using
quarterly data for the period of 1975 to 1999. Employing Johansen’s co-integration
technique and vector error correction model (VECM) they found that the stock
prices positively relates to industrial production, inflation, money supply, short
term interest rate and also with the exchange rate, but, negatively related to long
term interest rate. Their causality analysis revealed that every macroeconomic
variable considered caused the stock price in the long run but not in the short-run.
Valadkhani and Chancharat (2008) investigated the existence of cointegration
and causality between the stock market price indices of Thailand and its major
trading partners (Australia, Hong Kong, Indonesia, Japan, Korea, Malaysia, the
Philippines, Singapore, Taiwan, the UK and the USA), using monthly data spanning
December 1987 to December 2005. Based on the empirical results obtained from
these two residual-based cointegration tests, potential long-run benefits exist from
diversifying the investment portfolios internationally to reduce the associated
systematic risks across countries. However, in the short-run, three unidirectional
Granger causalities run from the stock returns of Hong Kong, the Philippines and
the UK to those of Thailand, pair-wise. Furthermore, there are two unidirectional
causalities running from the stock returns of Thailand to those of Indonesia and
the USA. Empirical evidence was also found of bidirectional Granger causality,
suggesting that the stock returns of Thailand and three of its neighbouring countries
(Malaysia, Singapore and Taiwan) are interrelated.
The impact of changes to the money supply on share prices was also investigated
by Shaoping (2008) who demonstrated very strong correlation between the money
supply and share prices in the conditions of the Chinese market between 2005 and
2007. Similar results were reached by Yuanyuan, Donghui (2004) on the Chinese
market.
Pimenta Junior & Hironobu Higuchi (2008) studied the relation of the causality
of interest rate (Selic), Exchange rate (Ptax) and the inflation rate (IPCA) on the
Ibovespa in the period from 1994 (after- Plano Real) to 2005. In this study, four
econometric tests were used: unit root test (ADF), Granger causality test, analysis
of the variance decomposition (VDC) and analysis of the Impulse and Response
functions (IRF). The results showed that the Exchange rate was variable with a higher
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  179

level of causality in the Ibovespa, however, this result is statistically inexpressive;

therefore, none of the variables selected presented causality relation to the index.
Using Johansen’s multivariate cointegration test and Innovation accounting
techniques, Adam and Twenenboah (2008) examined the role of macroeconomic
variables on stock price movement in Ghana by means of Databank Stock Index,
Treasury Bill Rate, Consumer Price Index and Exchange Rate as macroeconomic
variables and conclude that there is cointegration between macroeconomic variables
identified and stock prices in Ghana indicating a long run relationship. A cursory
examination of foreign exchange rate and interest rate history in Ghana shows some
considerable level of instability. Therefore, it would be interesting to explore the
effect of its foreign exchange and interest rate changes on its stock market. Again,
much work on the effect of the exchange rate and interest rate changes in the
developing country like Ghana has not been done. The study is therefore intended
to look at the effect of foreign exchange and interest rate changes on stock market
returns in Ghana.
Abugri (2008) investigated the link between macroeconomic variables and the
stock return for Argentina, Brazil, Chile, and Maxico using monthly dataset from
January 1986 to August 2001. His estimated results showed that the MSCI world
index and the U.S. T-bills were consistently significant for all the four markets he
examined. Interest rates and exchange rates were significant three out of the four
markets in explaining stock returns. However, it can be observed from his analysis
that, the relationship between the macroeconomic variables and the stock return
varied from country to country. For example from his analysis it is evident that,
for Brazil, exchange rate and interest rate were found to be negative and significant
while the IIP was positive and significantly influenced the stock return. For Maxico,
the exchange rate was negative and significantly related to stock return but interest
rates, money supply, IIP were insignificant. For Argentina, interest rate and money
supply were negatively and significantly influenced on stock return but exchange
rate and IIP were insignificant. But for Chile, IIP was positively and significantly
influence stock return but exchange rate and money supply were insignificant.
These results implies that the response of market return to shock in macroeconomic
variables cannot be determine a priori, since it tends to vary from country to country.
Maku and Atanda(2009) examined the long-run and short-run macroeconomic
shock effect on Nigerian capital market between 1984 to 2007. The macroeconomic
variables used were inflation rate, exchange rate, money supply and real output as
dependent variables. The results obtained using ADF and Error Correction Model
showed that the share index is more responsive to selected variables and thus have
significant impact on share index.
Arau´ jo (2009) studied the economic sources underlying the co-movement of real
stock returns in Latin America. Using structural VAR models, this study uses long-
180  l  ??????

run restrictions to identify three structural shocks: demand, supply, and portfolio
shocks. The paper reports that portfolio shocks are important factors behind real
stock returns for some countries only.
Tsouma (2009) investigated the dynamic interdependencies between stock
returns and economic activity in developed and emerging markets. The main focus
of this paper was on the existence, kind and strength of potential uni-directional
and/or bi-directional relations running from stock returns to future economic
activity and/or from economic activity to future stock returns. A bivariate VAR(12)
model and Granger causality tests are applied to monthly data covering the January
1991-December 2006 period. This paper reports an existence of an empirical
relationship, with forecasting ability, between stock returns and future economic
activity. The results indicate significant differences between mature and emerging
markets.
Aisyah, Noor and Fauziah(2009) examined the macroeconomic variables as
money supply, interest rate, industrial production index and reserves on Malaysian
Stock Index using VAR framework. The results proves that changes in Malaysian
stock exchange have co-integrating relationship the changes in selected variables.
Ngoc (2009) examined the effect of macroeconomic indicator of interest rate on
Vietnamese stock returns prices. This paper also shows the relationship between
US macroeconomic indicators and Vietnamese stock prices. To evaluate they took
monthly wise data from 2001 to 2008. This methodology analyzes the association
among stock price and macroeconomic indicator. He found statistically important
involvements between the domestic production sectors, money markets and stock
price in Vietnam while US macroeconomic significantly influences Vietnamese
stock prices.
Adamopoulos(2010) examined stock market and economic growth in Germany
using Vector Error Correction Model(VECM). GDP and inflation variables were
used as independent variables. Granger Causality showed results as unidirectional
between stock market causality and selected variables.
It is argued that inflation and stock prices are inversely related (Jaffe and
Mandelker, 1976; Bodie, 1976; Nelson, 1976; Fama and Schwert, 1977). This is
contrary to a priori expectations by the Fisher hypothesis of a one-to-one increasing
relationship between stock returns and inflation. Further empirical tests on the
response of stock returns to inflation in the 1980s by Fama (1981), Gertler and
Grinols (1982), and Solnik (1983), amongst others, also yielded similar results of a
negative relationship.
According to the reverse causality hypothesis of Geske and Roll (1983), the
reaction of stock markets to future economic activity is correlated with government
revenue. In the event of a budget deficit and a decline of real activity, there is
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  181

increased domestic borrowing or increased supply of money through the central

bank to balance the budget. The increase in domestic borrowing or issuance of
money has inflationary effects that dampen real activity. In the end, stock market
returns also fall due to a fall in real activity and the inflationary effect; hence the
negative relationship between stock market returns and inflation. Empirical works
however continue to produce mixed results (Gultekin, 1983; Solnik, 1983; Ely and
Robinson, 1994; Groenewold et al., 1997; Caporale and Jung, 1997; Barnes et al.,
1999; Boyd et al., 2001).
John and Owusu-Nantwi (2011) used Full Information Maximum Likelihood
Procedure to find relationship between inflation rate, treasury bills and exchange
and Ghana Stock exchange return. It was found that inflation had positive significant
impact on GSE and treasury bills and exchange rate have significant negative impact.
Oskenbayev et al (2011) investigated the causal relationship between
macroeconomic indicators, including the index of industrial production, inflation,
exchange rate, oil prices volatility, volume of trade and long & short term interest
rates, and the Kazakhstan Stock Exchange (KASE). They measured the long-term
relationship using Autoregressive Distributed Lag model, while they used the
Johansen cointegration test and Granger causality test for identifying the equilibrium
relationship.
Asaolu and Ognumuyiwa (2011) investigated the impact of macroeconomic
variables on Average Share Price for Nigeria for the period of 1986 to 2007. The
results from their causality test indicated that average share price does not Granger
cause any of the nine macroeconomic variables in Nigeria in the sample period.
Only exchange rate Granger causes average share price. However, the Johansen
Co-integration test affirmed that a long run relationship exists between average
share price and the macroeconomic variables.
Akbar et al. (2012) examined the relationship between the Karachi stock
exchange index and macroeconomic variables for the period of January 1999 to
June 2008. Employing a co-integration and VECM, they found that there is a long-
run equilibrium relationship exists between the stock market index and the set of
macroeconomic variables. Their results indicated that stock prices were positively
related with money supply and short-term interest rates and negatively related
with inflation and foreign exchange reserve.
Mgammal (2012) investigated the result of numerous variables (interest,
exchange rate and inflation rate) on stock prices. The study applied on two gulf
countries; United Arab Emirates (UAE) and Kingdom of Saudi Arabia (KSA) for
the time from January 2008 to December 2009. They found that for short term, the
exchange rates influence positively on stock market price index for United Arab
Emirates while having no relationship between them for Kingdom Saudi Arabia.
182  l  ??????

The result of study in long term shared that exchange rate influence negatively on
stock market price index for United Arab Emirates.
Attari & Safdar (2013) found the relationship between macroeconomic volatility
and stock market volatility. They took data from December 1991 to august
2012 monthly wise. They used three variables; inflation rate, interest rate, and
gross domestic Product and performed exponential generalized Autoregressive
Conditional Heteroskedasticity technique. They concluded that stock prices affect
the economics level of country.

3. LITERATURE REVIEW (ON INDIAN MARKET)

There have been several studies on this in Indian context. Sharma Kennedy (1977)
and Sharma (1983) test the weak-form efficiency of the BSE. Both of these studies
with the former covering the 1963-1973 period and the later encompassing the
1973-1971 period, conclude that Indian stocks generally conformed to random-walk
behaviour in that successive period changes were independent. Poterba & Summers
(1988), however, find evidence of mean reversion in Indian stock prices, suggesting
a deviation from random-walk behaviour.
Darat and Mukherjee (1987) applied a Vector Auto Regression (VAR) model and
found that a significant causal relationship exists between stock returns and selected
macroeconomic variables of China, India, Brazil and Russia which are emerging
economies of the world using oil price, exchange rate, and moving average lags
values as explanatory variables employed MA (Moving Average) method with OLS
(Ordinary Least Square) and found insignificant results which postulate inefficiency
in market. Finally they concluded that in emerging economies the domestic factors
influence more than external factors, i.e., exchange rate and oil prices.
The behavior of stock price (BSE) in relation to some key macro economic
variables in India during the scam period 1992 was studied by Bhattacharya and
Chakravarty (1994). Their dynamic forecasts indicate that the behavior of stock
price is unrelated to key macro variables.
Abdalla and Murinde (1997) investigated the intersections between exchange
rates and stock prices in the emerging financial markets of India, Korea, Pakistan
and the Philippines. They found that results show unidirectional granger causality
from exchange rates to stock prices in all the sample countries, except the Philippines,
where they found that the stock price lead the exchange rate.
Raj Kumar and Bhartendu Singh (1998) observed that the joint impact of trading
volume, rate of exchange and the rate of gold standard was highly significant on
Sensex. The individual effect of rate of exchange and rate of gold standard on Sensex
were also found highly significant but the individual effect of trading volume was
not found significant.
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  183

Pethe and Karnik (2000) employed co-integration and error correction model to
examine the inter-relationship between stock price and macroeconomic variables
using monthly data from April 1992 to December 1997. Their analysis revealed that
the state of economy and the prices on the stock market do not exhibit a long run
relationship.
Bhattacharya and Mukherjee (2002) studied the nature of the causal relationship
between stock prices and macro aggregates in India by using the methodology
proposed by Toda and Yamamoto for the period of 1992-93 to 2000-2001.Their results
show that there is no causal relationship between stock price and macro economic
variables like money supply, national income and interest rate but there exists a two
way causation between stock price and rate of inflation. According to them index
of industrial production lead the stock price. They further investigated the causal
linkage between stock prices and macroeconomic aggregates in the foreign sector
in India like exchange rate, foreign exchange reserves and value of trade balance
by applying the technique of co-integration and long run Granger non causality
test developed by T&Y(1995). Their results suggested that there is no causal linkage
between stock price and the three variables.
Seshaiah et al (2003) examined the impact of inflation and exchange rates on
gold, silver and stock returns before and after liberalization. They found that over
the longer period of time, positive real rate of return was being provided by stocks
after liberalization, by gold in both periods, but in short run the real return of stocks
was often negative. Negative real rate of return was being provided by silver in
both the periods
Ray and Vani (2003) employed a VAR model and an artificial neural network
(ANN) to examine the linkage between the stock market movements and real
economic factors in the Indian stock market using the monthly data ranging
from April 1994 to March 2003. The results revealed that, interest rate, industrial
production, money supply, inflation rate and exchange rate have a significant
influence on equity prices, while no significant results were discovered for fiscal
deficit and foreign investment in explaining stock market movement.
Mukhopadhyay and Sarkar conducted a systematic analysis of the Indian
stock market returns prior to and after market liberalization and the influence of
macroeconomic factors on returns. Specifically for the post-liberalization period
(since 1995), real economic activity, inflation, money supply growth, FDI, and the
NASDAQ-index were significant in explaining variations in Indian stock return.
Nominal exchange rate, while significant during the pre-liberalization period (1989-
1995), was found to not be significant after liberalization.
Mishra (2004) examined the relationship between stock market and foreign
exchange markets using Granger causality test and Vector Auto Regression
technique .They used monthly data for stock return exchange rate, interest rate and
184  l  ??????

demand for money for the period 1992 to 2002. The study found that there exists
a unidirectional causality between the exchange rate and interest rate and also
between the exchange rate return and demand for money. The study also suggested
that there is no Granger causality between the exchange rate return and stock
return.
Sangeeta Chakravarty (2005) reexamined the relationship between stock price
and some key macro economic variables in India for the period 1991-2005 using
monthly time series data. She found unidirectional effect of IIP and inflation Granger
causing stock prices and stock prices granger causing money supply. On the other
hand there is no causal relation between stock price and exchange rate, and between
gold price and stock price.
Vuyyuri (2005) investigated the cointegrating relationship and the causality
between the financial and the real sectors of the Indian economy using monthly
observations from 1992 through December 2002. The financial variables used were
interest rates, inflation rate, exchange rate, stock return, and real sector was proxied
by industrial productivity. Johansen (1988) multivariate cointegration test supported
the long-run equilibrium relationship between the financial sector and the real
sector, and the Granger test showed unidirectional Granger causality between the
financial sector and real sector of the economy.
Robert and Gay (2008) investigated the effect of macroeconomic variable on
stock market returns of Brazil, Russia, India and China using ARIMA model. The
results showed no significant relation was found between either exchange rate or
oil price on stock market index prices of either BRIC countries.
Paritosh Kumar (2008) validated the long term relationship of stock prices with
exchange rate and inflation in Indian context.
Ahmed (2008) employed the Johansen’s approach of co-integration and Toda
– Yamamoto Granger causality test to investigate the relationship between stock
prices and the macroeconomic variables using quarterly data for the period of March,
1995 to March 2007. The results indicated that there was an existence of a long-
run relationship between stock price and FDI, money supply, index of industrial
production. His study also revealed that movement in stock price caused movement
in industrial production.
Kandir (2008) revealed the impact of interest rates and foreign exchange rates
on share prices in Turkey and said that industrial production, money supply and
oil price do not affect share yields on this market.
Samuel Imarhiagbe (2010) analyzed the impact of oil prices on stock prices of
selected major oil producing and consuming countries with nominal exchange rate
as additional determinant. Daily stock prices, oil prices, and exchange rates for six
countries (Mexico, Russia, Saudi Arabia, India, China, and the US.) from January
 Impact of Macroeconomic Variables on Stock Market: A Review of Literature  l  185

26, 2000 to January 22, 2010, are modeled as a co integrated system in Vector
Autoregressive analysis.
Singh (2010) examined causal relationships between macroeconomic variables
and Indian stock markets. He considered three macroeconomic variables, IIP, WPI
and exchange rates. He applied Granger causality test for this purpose. He found
that IIP was the only macroeconomic variable causing changes in SENSEX.
Dash and Rao (2011) found that the APM did not have significant better
explanatory power over the CAPM for Indian capital markets. Apart from the
market factor, they found that interest rates (the MIBOR factor) have a significant
role to play in influencing asset returns; but the market factor was found to be the
most influential of the factors, more than twice as important as interest rates.
Pal and Mittal (2011) investigated the relationship between the Indian stock
markets and macroeconomic variables using quarterly data for the period January
1995 to December 2008 with the Johansen’s co-integration framework. Their analysis
revealed that there was a long-run relationship exists between the stock market
index and set of macroeconomic variables. The results also showed that inflation
and exchange rate have a significant impact on BSE Sensex but interest rate and
gross domestic saving (GDS) were insignificant.
Pramod Kumar Naik and Puja Padhi (2012) observed bidirectional causality
between industrial production and stock prices, unidirectional causality from money
supply to stock price, stock price to inflation and interest rates to stock prices. The
authors conclude that macroeconomic variables and the stock market index are
co-integrated and, hence, a long-run equilibrium relationship exists between them.
Narayan and Narayan (2012) in­vestigated whether U.S. macroeconomic
conditions (specifically, the exchange rate and the short-term interest rate) have
effects on seven selected Asian stock markets—namely, China, India, the Philippines,
Malaysia, Singapore, Thailand, and South Korea—us­ing daily data for the period
2000–2010. They divided the sample into a pre-crisis period (pre-August 2007) and
a crisis period (post-August 2007). They found that in the short run, the interest
rate has a statisti­cally insignificant effect on returns in all countries, except for
the Philippines during the crisis period, and that depreciation has a statistically
significant and negative effect on returns in all countries except China (regardless
of the crisis). With respect to long-term re­lationships among the variables, although
the authors found cointegration in the pre-crisis period for five of the seven countries
(India, Malaysia, the Philip­pines, Singapore, and Thailand), they found no such
relationship during the crisis period, implying that the financial crisis has actually
weakened the link be­tween stock prices and economic fundamentals.
Mohapatra and Panda (2012) correlated top ten rises and top ten falls of
Sensex with corresponding net flows of FIIs and also tested the impact of other
186  l  ??????

macroeconomic factors along with FIIs affecting Sensex for a 10 year period and
found that IIP and Exchange rate (INR/USD) have a higher influence than FIIs on
the stock markets.

4. CONCLUSION
In the last few decades, the growing research interest in and importance of
impact of macroeconomic variables on stock market has engendered a plethora
of contributions on this topic. This paper has attempted to provide a picture of
body of researches produced in the field of impact of impact of economic variables
on stock market during the period from 1960s to recent. Firstly we can conclude
that most variable covered are inflation, exchange rate, IIP, GDP/GNP, money
supply, interest rate, treasury bills. Also most researches are done on developed
nations’ or developing nations’ stock indices like US, Great Britain, China, India,
Singapore.
Thus research gap is found that still underdeveloped nations and developing
nations like Bangladesh, Afghanistan, Nepal, African nations’ etc. can be covered
with variables like Imports, Silver, different commodities traded, Purchasing power
parity, Total Reserves, Tax Reserves, Revenues, Expenditures which are least
covered or not at all covered. Thus large number of researches can still be done on
the same topic but different variables and on different stock markets.

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