Economic Growth, Expected Stock Returns and Volatility: A Case of Indian Stock Market

Abstract

Stock market volatility is a matter of great interest for researchers and policy makers. The present study examines the volatility of daily, weekly and monthly stock returns in view of economic growth rate. It investigates the hypothesis that high economic growth rate tend to stabilize the investment decisions and create certainty among the investors. Under such situations, investors prevent to alter their investment decisions spontaneously with regard to good or bad news. A low growth rate, on the other hand, makes their investment decisions highly volatile. The study examines the Bombay stock exchange listed index BSE 100 data for the period from 1996 through 2007, wherein Indian economy has registered high and low growth rates. It also examines additional aspect of volatility with regards to expected and unexpected variations in stock returns by applying AR(1)-GARCH(1,1) model. The findings report that investors are not sensitive to economic growth rate for short period, but they become largely sensitive with the long investment horizons. The direct observations can be made here, volatility is invariable to economic growth rate in short time period, but investors with long investment horizons are largely affected by economic growth rate. Briefly, high volatility tends to associate with low economic growth rate and low volatility is associated with high economic growth rate.