Macroeconomic and Firm Specific Determinants of Stock Returns: A Comparative Analysis of Stock Markets in Sri Lanka and in the United Kingdom

Abstract

This paper examines the relationship between macroeconomic and firm-specific determinants of stock returns of Sri Lanka and United Kingdom (UK). Our results are based on the fixed effects regression models since those perform statistically better than the random effects and pooled OLS models for Sri Lankan data and the fitted one-way fixed effects firm factor regression indicates that Return on Assets ( ROA) and sales growth rate play a significant role in explaining variation in stock returns in Sri Lankan companies while one-way random effect firm factor model in UK shows that E/P ratio, B/M ratio, fixed assets growth rate, size and ROA are the most dominants priced factors in London Stock Exchange (LSE). The explanatory power of regressions increases considerably when we incorporate macroeconomic indicators controlling for firm effects and results show that inflation, GDP and exchange rate remain leading predictors of stock returns variation in both Colombo Stock Exchange (CSE) and LSE whereas unemployment and Foreign Portfolio Investments (FPI) become statistically significant only in CSE. Thus, it is noted that stock prices of Sri Lankan and UK companies are sensitive to both company and macroeconomic fundamental changes hence, the stock market analysts and investors find that they can make fundamental base trading strategies as publicly available information play a key role in predicting future returns bringing the conclusions of the Sri Lankan stock market is in semi-strong form efficient in doubt.