Stock Market Performance and Macroeconomic Factors: The Study of Indian Equity Market

Abstract

There has been an extensive debate on the relationship between real economy and stock market performance especially in the context of emerging markets. This article examines the causal relationships between the stock market performance and select macroeconomic variables in India, using monthly data from July 1997 to June 2011. We use factor analysis, ADF and PP Unit root tests, Regression, ARCH model, Granger causality and Johansen Co-integration test for data analysis. Impulse Response analysis has also been performed to check the response of stock market to shocks created in the real economy. We find a significant correlation among stock market indicators and macroeconomic factors. We identified three principal factors through Factor analysis viz Inflation, Interest rate and Exchange rate. The overall explanatory power of the regression model is 23.8%, 23.3% and 16.9% respectively for Sensex, Market capitalization and Market Turnover. There is uni directional causality from stock market to real economy. We find five co-integrating relationships between stock market and macro-economic variables. These results suggest that the stock prices movement is not only the result of behaviour of key macroeconomic variables but it is also one of the important reasons of movement in other macro dimension in the economy.