Abstract
This paper examines short-run and long-run dynamic relationships between selected macroeconomic variables and stock prices in the China Stock Exchange proxy by Shanghai Composite Index. The data is restricted to the period for which quarterly data are available from 1992 Q1 to 2019 Q4 (112 observations) retrieved from the Federal Reserve Bank of Saint Louis, GTA-CSMAR database, and CEIC Database. The study employs unit root test, cointegration test, vector error correction estimates, and Innovation Accounting (impulse response test). A Johansen-Juselius cointegration test indicates a positive long run relationship between the Chinese stock price index and exchange rate, and a negative long run relationship with the gross domestic product, and M2 money supply. An estimated vector error correction model (VECM) suggests significant unidirectional short run causal relationships between Chinese stock market returns and money supply but not for 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 Chinese stock market converges to the equilibrium within half a year. Impulse response function analysis shows no significant relationship between China stock market returns and the macroeconomic variables. Forecast error variance decompositions suggest that 76% of the variation in Chinese stock market returns is attributable to its own shock, which implies that Chinese stock market returns are relatively independent of the macroeconomic variables in the system. Keywords: Stock Prices, Macroeconomic Variables, Cointegration, Innovation Accounting, China. JEL Classification : G15, E44, C58, O53 DOI: 10.7176/RJFA/12-6-02 Publication date: March 31 st 2021
Highlights
The recent unprecedented volatilities in stock prices have prompted the necessity to probe into numerous of questions about the relationship between the stock market returns and the rest of the macroeconomic variables such as interest rate, inflation, exchange rate, consumption, production, money supply and others
Ralph Chami (2008) found that the level of household income is determined by some macroeconomic variables such as wage rate, interest rate, production and a host of others which gives the basis to assume the existence of a causal relationship between some macroeconomic variables and stock prices
From a long-term perspective, policymakers should consider selected macroeconomics such as gross domestic product, money supply and exchange rates as policy tools aiming at the Chinese stock market since the results show evidence of a long-run equilibrium relationship among them
Summary
The recent unprecedented volatilities in stock prices have prompted the necessity to probe into numerous of questions about the relationship between the stock market returns and the rest of the macroeconomic variables such as interest rate, inflation, exchange rate, consumption, production, money supply and others. The assessment of financial development and macroeconomy in this literature include more than just those relating to the stock market and range from assets and liabilities of banks and nonbank financial intermediaries to the size of the bond market relative to the economy as a whole, as well as stock market capitalisation and turnover variables (Groenewold et al, 2008). The focus of these literature is usually long-run in nature and employs large cross-country large database with the variables in focus measure in multi-year average to help explain the long-run nature of relationship between the variables of focus. Other researchers who studied the relationship between stock returns and macroeconomic variables in developed countries such as Japan, US, Australia, Canada and European countries (see, inter alia, (Cheung and Ng, 1998); McMillan and Humpe, 1997; Mukherjee and Naka, www.iiste.org
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