Abstract:
This study investigates the effects of selected six macroeconomics variables: inflation rate,
economic growth, exchange rate, interest rate, money supply and international crude oil prices on
stock market and sector returns in the Colombo Stock Exchange using quarterly data from 1st
quarter of 1996 to 4th quarter of 2018. All series were converted to logarithm form to reduce
heteroscedasticity. Augmented Dickey Fuller and Phillip-Perron tests confirmed that all variables
have unit root and integrated at first order. It was found that there is a long term relationship
between macroeconomic variables and stock market and sector returns, separately and also have
equilibrium long term relationship. Furthermore, short term dynamics between macroeconomic
variables and stock market and sector returns were also identified using VECM. Economic growth
and interest rate are significant and inflation, exchange rate, money supply and international crude
oil price are not significant in explaining stock market returns in the long term. However, no
macroeconomic variable is significant in explaining stock market returns in the short term. Laws
and regulations governing the operations of the stock exchange should be strengthened to protect
the interest of buyers and sellers on the stock market. This will increase the confidence of
investors as well as boost domestic investor participation and enlarge stock ownership base in the
economy.
