Interdependence and Dynamic Interactions Among Fundamental Factors and Stock Prices

Abstract

This paper investigates the interdependence and dynamic linkages between fundamental drivers of stock market like exchange rate, interest rates, oil prices, Foreign Institutional Investors (FII), Mutual Fund(MF) investment and stock prices as a dynamic system. The study also examines the asymmetric impact of positive and negative FII and MF investment on stock prices. This study uses a LA-VAR along with generalized impulse response functions and variance decomposition analysis to examine the nature of relationships between fundamental drivers and stock prices. The study examines in detail how the subprime crisis impacts the nature of interrelationship between fundamental drivers and stock prices by dividing the data sample into pre crisis, crisis and post crisis periods. The study shows how different market players are responding to the changes in fundamental drivers and how stock market is responding to the fundamental drivers. The study outlines the relative contribution of each of the fundamental drivers in terms of the impact and contribution to each of the other factors in the entire system. The shocks in exchange rate significantly decrease both FII and the large cap stock prices. The results show mutual funds are selling when FIIs are buying. Stock prices appreciate as result of FII and MF investments. Oil price does not cause stock prices but has a significant positive impact on the stock prices. The proportional impact of selling done by institutional investors on stock prices is much higher than buying. FII investments are mainly determined by the levels of broad market index. The influence of external factors has increased for large cap and midcap stocks after the subprime crisis.