Impact of macro-economics variables on stock market returns and sector returns using multivariate time series approach

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.