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Stock Market and Macroeconomic Variables in India

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Investment is dependent on human behavior. Keynes (1936) elaborates which sort of behavior humans adopt while investing particularly in capital market. Usually people get in use with their “animal feelings” and “flock mentality”. Economic and social and political environment also affects the opinion of people and they force them to think several times before investing. This is the reason one cannot forget the fact that the value of economic activities and information nourished to the market is vital. Here we are going to discuss the tendency of animal spirit in India. The propensity of animal spirit in India is very much high-flying. The major reason for this is that only 2% of the population of India participates in such activities. The medium to get knowledge of market and accuracy in information is not available easily. This forces people to act as per their nature rather than their logic. The core theme of this analysis is the study of interrelation between real economic variables and capital market variables. The significance of this relationship has got marvelous recognition in the past due to roller-coaster ride of the BSE. A few academics also claim that it is not greatly shored up by the financial basics.

To determine the character of these basics in studying the stock prices, different people have done different researches. Amidst of these thoughts, some fundamentalists have tailored theory of Efficient Market Hypothesis (EMH). This theory was further extended by Fama in 1971 to narrow and categorize such business centers on the foundation of their response and data nourished to them in feeble, partially built and well-built markets. Another theory which is Popular Model Theory shows a different perspective in general. This theory explains the qualitative clarification of price which shows that most of the people proceed inappropriately to the information which they get and easily accessible information is not included in stock market price as Efficient Market Hypothesis verifies which is also much analogous to Keynes model.

These days, everyone in the world is running after word money (finance). Nothing is possible without money and economy and other financial operations including growth of this whole world are also dependent on the same. Without finance, no one can turn the wheel of economy at 360 degree, because each and every transaction needs money at its core. Amadou (2007). In the past, there was a system in use, which is barter system. To avoid its complications, ‘money'- component of finance was introduced and as then, money has been the most precious thing of the world. It has become a need for every individual to fulfill the requirements. Money is the core object needed to establish a business. The most valuable source of this sort of money is the post laissez-faireization period is stock markets. In today's world, each and every individual can witness the appearance and acceptance of the capital markets in the period of Globalization. This is considered to be highly regarded as an award for the globalization years to under developed regions to enlarge and reinforce their nitty-gritty as their financial crisis is gratified to an extent by these stock markets. Capital markets are also considered to be a profitable platform for firms to get financing for their new or forthcoming projects and moreover for people as a prospect to invest with chances of risk but huge profits. The establishment of such capital market is the most important aspect for companies and individuals. It is also a valuable state of the prerequisite of economy on the degree required in a contemporary varied economy. The subsistence of such markets persuades the existence of such arguments shaped in the hoisting of money can be transmitted.

Current Situation

“Thus if the ‘animal spirits' are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;-though fears of loss may have basis no more reasonable than hopes of profit had before. . . . . . . But individual initiative will be adequate only when reasonable calculation is supplemented and supported by animal spirits. . . . . . . .”

- Keynes (1936).

In the above quote, Keynes (1936) has very bluntly and accurately explained the reasons undercover of the current situation along with the entire humankind is getting exaggerated in our day in 1936 merely in one of his leading models. A few economists have also accepted in an extremely enjoyable method which it is not the object that the worth of our productivity has decreased or lowered but just only the animal feelings are fainted and what we were expecting is that the value of our capital market has boosted is wrong in comparison with the primordial epoch and regard as added rise in actual value improbable. And every financial system requires such “animal spirits” or the positive behavior along with the estimated threats and reserves to became visible and outshine and development.

Since her independence, India was following the socialistic outline for growth, but after the 1990's financial crisis, India had to make some strict financial improvements as proposed by World Bank. The most vital factors of that package were financial liberalization. This financial change cemented a new way for India to boost its economy and make developments and gave India impulsive environment to the financial markets specifically in language of BSE BSE which is supposed to be solitary of the major components of India's fiscal hike. These days, capital markets has considered to be the most valuable source to transform domestic savings to upcoming productive projects and provides a chance to the country to develop. Brigham & (2008)

According to a survey conducted in India, around two percent of the general populace is directly caught up in capital markets but when anything happens to such financial markets, it is the whole population which get affected, which clearly shows the correlation, impact and importance of these capital institutions and actual economy not only on the ground intensity but also bottomless within the main rank. In these days, newspapers are bombarded with such sort of news and major newspapers also issue supplement for financial news. Due to such releases, there is a little doubt that the macroeconomic news which is vital to capital market will be affected. In recent years, the whole financial market of the world had crashed and with the recession in capital market, a gap has been established which lead to decrease real economic fundamentals.

Consequently, it also boosts the value of this study because the focal point of this downturn is considered to be the capital markets and if we consider it the other way, a nation can become economically strong by considering such markets. So, it can easily be said by any person that it seems to be that the stock prices will go up and would result in the formation of some talented analysts of upcoming values of macroeconomic pointers similar to productivity growth and price increases. If one takes this thoughts then this would definitely result in arose of two more questions that what will make the market create hyper boom and incorporation of capital market with other marketplaces. Agrawal (2008)

The most suitable reply to be given to the earliest query is that the flow of information rise which has crowded the market, for instance, media (commerce news channels). Another rebellion that shocked the market is Information Technology. The shortage of skilled people in IT in the US has also become highly required after stocks due to their fantastic dough take home power.

The other question which is creating a fuss is regarding the connection of such capital markets with the actual financial system. Different analysts have also studied regarding this theory and worked on this linkage. Ando and Modigliani (1963) developed a theory called life cycle theory which is based on the linkage between stock prices and actual spending. The theory talks about the individuals' decisions and states that people mark their expenditure verdicts on the conventional life span earning, division of which might be detained in capital connecting to capital cost variation to variation in using up expenditure. Beck & Levine (2001 & 2008)

In the same manner, the linkage between capital costs and investment spending is supported by q theory. The q theory is designed by James Tobin (1969) to analyze the effect of stock prices on investment spending, where q stand for fraction of total retail worth of comapnies to the substitute value of their on hand capital market at recent stock prices. In addition, we had also discussed EMH model. With this research we have concluded that none of these theories fit into the actual and recent image of stock markets. Some fit partially but no one is perfectly related. To analyze such issues, there should be more research to be done on this for better understanding and the below paragraph communicates it in an improved way.

“We should not conclude from this that everything depends on the waves of irrational psychology. On the contrary, the state of long-term expectation is often steady, and, even when it is not, the other factors exert their compensating effects. We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, can't depend on strict mathematical expectation, since the basis for making such calculation does not exist, and that it is not innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance.” Keynes (1936).

Structure of the Dissertation

This study is stepped into five chapters and this is to be pointed that the register worth has been taken from all the factors. The first chapter thoroughly gives the overview of the current situation. The second chapter is based on the literatures related to our study. The third chapter comprises of a bunch of points and statistics and method considered in this analysis. The fourth chapter will explain the estimations and result analysis. Chapter five exemplifies the results, policy insinuations and boundaries of this analysis effort.

Research Questions

  1. What is the relationship between stock market and macroeconomic variables in India?
  2. Is there an informal relationship between capital market and real economy?
  3. What is the influence of investment on financial health of India?



The word economics has emerged to be the most powerful word. Each and every individual is running after money and always try to earn as much as the one can within the shortest possible span. Without finance, no one can imagine running any sort of business and it has become an essential which runs the businesses and all the major features begin and finish at it. In recent world, the quickest and trouble-free way to earn money for new and challenging projects is to publicize or to enter into the stock markets where a little investment can make the wise firms accelerate and helps these firms to become giants amongst the other big names. Chauvet (2009) There are around two percent of the entire inhabitants in India which is caught up in stock markets but the whole population in India gets affected either directly or indirectly if anything good or bad occurs in such markets. This clearly shows that Capital Markets and Actual Economy both have strong and vital link on not just only the lesser stage but also on the higher stage. A number of studies and researches have been done in this regard but the outcomes are vague. The reason for this is that most of the researchers have found a tough bilateral linkage among capital markets and actual economy. On the other hand some researches have entirely rejected this analysis that stock markets and real economy are correlated.

To study more deeply we can distribute numerous theories in 3 schools of thoughts on the ground of the literature review: first school of thought says that there is no linkage between capital market and real financial factors. The second school of thought has analyzed that there is an informal link among stock market and macro economic variable. The last one which is third school of thought promulgates an unclear belief that there is a relation between the two but not positively in both short and long run. Pindyck (2004)

This research is comprised of some on hand literature which has been reviewed relating to the above problems. Below we have discussed the overall findings of different researchers.

First School of Thought

Chowhan, P.K. et al. (2000) The first school of thought attempted to obtain reasons for hurly-burly in capital market in small period in India considering BSE as the major indicator. In the period from 2008-2000, capital markets in India had shown irregular and unstable activities which does not go with the information provided to them. Due to the severe up and down in the stock prices, the investor confidence resulted in turmoil in the markets. The school of thought tried to explain that what could be the actual causes at the back of instability and what made Efficient Market Hypothesis (EMH) by Fama can't explain the reason. The researchers attempted to find out the reason of such huge rise in BSE stock value. On October 2008, BSE was at 2761 and in February 2000 it went at 6000, which shows 117% appraisal in just 15 months, which is not powerfully maintained by basic financial factors in this era because Indian economy boosted just only 5.9% in 2009-2000. On the other hand, the corporate profit raised by 32%while the accumulated growth rate for industrial production during Apr-Dec 2009 was reported to be 6.2%. The rate of inflation in September 2008 was 8.8% while in 2009-2000 it has also jumped down to 2.9%. This research shows that long run financial factors such fluctuations in stock prices. India's GDP in addition did not prove any hike in the past years. Not only India was affected with this situation but also other countries as well. The economists found some reasons to create a boost in Indian stock markets, they are:

  • Information hike;
  • IT impact;
  • Internet fable;
  • Feedback outcome;
  • Cultural alteration.

Another economist Sarkar, P. (2007) states that if there exists any significant correlation between growth and capital accretion, they have to use yearly information on numerous financial factors like, insignificant and actual share price, capital market turnover, companies which are stock market members, fixed stock structure and enlargement of actual GDP and production results. Despite, all the researchers tell the same thing from 2000-1951 till 2005, there are no correlation actual and capital market variables neither in short nor in long run. In addition, Sarkar also researched new movements and came to a conclusion that most of the financial variables are unstable and comprised of an upswing movement in mid 1970s.

The tactics used in this thesis to get the best possible results is Unit Root tests. These tests are used to obtain a fixed and worthy degeneration analysis. Besides these studies, OLS and MLE approaches are also utilized for determining the sequence of auto-linkage of the remaining and handling with it. To estimate long-term and short-term relationships in a better manner, ECM and Autoregressive Distributed Lag (ADRL) respectively are used in this thesis.

Shiller, R. (1990), an economist of University of Yale, had researched and tried to compare the normal & meager compound Capital Price Index from 1871-2000. He concluded that the capital price instability is not compared by the profits.

Second School of Thought

In 2001, Black tried to elaborate the interlinkage between the U.S. capital costs and real economic variables. Black gathered 54 year periodical data and along with it used VAR model supported by hypothetical structure to study relationship between capital prices and macro financial variables. With the lime light on actual results and considering current value approach, Black found that the basic price-output ratio and the basic capital price in the light of various suppositions relating to time variation of income, and to contrast such values to the real data.

Black studies 3 situations, in the first one, he initiated supposing that the individuals expect fixed return as being the wealth holder and then support this supposition by first, permitting the undisruptive rate to differ in due course and next the risk payment to be time changeable. Although there is a variation in models results, most mean that the capital market has comparatively been overestimated in comparison with its value expected from growth rates. According to reports, the ratio of stock market capitalization with GDP has boosted to be thrice as compared to last twenty five years in the US. From this figure, in mid 1970s less than 30% and in 1990s it was 80%. The point which is to be noted here is that it does not only seem that the capital market has risen in 1990s but its link with the actual finances has turned out to be well-built and due to which it got accredited. As per the records, capital market has been associated with actual financial variables by numerous techniques, out of which one of them is asset costing perception in which Arbitrage Pricing Theory is second-hand as structure to analyze the impacts of actual economic measures on capital costs concentrating on the question that will the risk allied with a few real financial variables is replicated in probable asset takings. On the other hand, there also exists expenditure-CAPM study of expenditure which deliberates on a particular real factor power. There are other researches also conducted to analyze the relation between capital prices and investment when stock prices hide the actual economy which can be doled out with. In recent times, a lot of researches have aroused analyzing the mutual linkage between capital worth and actual financial factors with VAR models as the structure, devoid of any particular hypothetical formation.

Bulmash (2003) has done a very distinctive analysis to elaborate the interaction between company investments and stock markets. He also studied that how investments affect stock markets and vice versa. This theory also reflects how investments respond faster than customers in capital markets. In his previous researches, Bulmash showed that what makes one capital market to get boosted just by the difference in returns of economies. And finally results in unity of this income fetch the stock into association in the long term. It has also been proved that what makes these stock markets covert into analysts of the future financial flows. It has also showed the linkage between capital investment markets and actual financial variables through a system that value of capital market will boost when:

  • Firms increase their investment to enlarge their operations which will increase the GDP.
  • With the increase in capital, actual capital also amplifies because buyers also raise their expenses which accelerate GDP.
  • Such points will result in worth formation which will lead to real economy.

Third School of Thought

A renowned economist, Mustafa in 2007 has done an analysis on the linkage between capital market and actual financial market in Pakistan. For his study, he took a number of economic variables like, per capita GDP, productivity growth and capital market liquidity, volume of capital market highlighting the financial Market. He took up co-amalgamation and Error Correction Model method to set up the pragmatic link, if any among the two from 1980-2004.

The probable outcomes points that the activities in the capital market of Pakistan elaborate the per capita GDP and productivity growth for small period only. On the other side, financial growth variables elaborates capital market factors in nearby as well as in long term which shows that the enlargement of capital market relies on by and large development of economy in Pakistan. The economy of Pakistan had not been affected by the acceleration in Karachi Stock Exchange which signifies that the elevated instability is not out of the ordinary of the up-and-coming stock markets. The previous theories related to this subject used stock prices as capital market movement sign and utilization, price rises, industrial output, financial flow, rate of interest as real financial factor. Mustafa's theory is quite different from other's work because the variables are different as used by others. The analyst have come to a conclusion on the basis of empirical results that in Pakistan the stock market is way behind and it needs to develop to be vital in the economy of Pakistan with the help of other financial institutions. In any nation's economic growth, capital markets play an important role but capital market is inactive in the growth of a nation unless it is in its emergent stage.

Another big name amongst economists is Hussain, F (2010). He also studied about the linkage among stock price and actual economy of Pakistan. He gathered data from 1959 till 2004 or 2005. After getting data, he distributed it in 2 halves, which are pre and post liberalization and with the help of this activity he analyzed the linkage between stock price and actual economy by applying different econometric tactics like ECM, Engle-Granger co- integrating regressions and Augmented Dickey Fuller (ADF) Unit Root tests. The delay period was decided in all the cases on the foundation of the two, i.e., Final Prediction Error and Akaike Information Criteria (AIC). By applying such techniques Hussain examined that there exists long term linkage between capital worth and actual financial factors.

On the subject of the causal section, he has brought into being unilateral grounds from actual market to stock costs. This highlights that the stock markets in Pakistan are yet in a developing stage. They have not got developed to influence the actual variables of economy and because of that they cannot be considered as most important sign of the monetary activity. It means that Government of Pakistan can utilize actual sector to power the capital market.

Another study observes that in India, the incorporation between Foreign Exchange and Stock market in liberalization period. The researchers tried their level best to find out the link flanked by Foreign Exchange and Stock market by using goods market approach and portfolio balance approach. To narrow the research, they have used a number of econometric techniques Granger's causality test in VAR structure, which is supported by F-Test to test this theory; and to examine such chains for immobility, ADF Unit Root Test is useful. One more econometric test is applied which is Gweke's Measures for the degree of business center amalgamation. But the point is that this study gave new outcomes which are totally different. The previous examinations reveal that there exists an informal linkage among income in foreign exchange and stock markets. While as per the final analysis, there is a high extent of assimilation among foreign exchange and capital markets and there is still two dimensional as well as simultaneous informal linkages between foreign exchange and stock markets. Figlewski (2001)

Out of one of the many various kinds of papers written by Brenner, M., et al. (2010) have studied the nearby prevision and reaction of U.S. stocks, treasury bonds, and commercial bond places to the initial public announcement of major macroeconomic bulletin on employment, inflation, and interest rates.

Four essential set of queries have been examined under this study. These are listed below:

  • Whether these traded assets in the markets are more responsive to instability prior to release of these public announcements or less impulsive in nature afterwards?
  • Are various asset class influenced in a different way by these public announcements?
  • Is the prevailing degree of correlation between various assets being affected by these macroeconomic announcements?
  • Do the influences of such public announcements occur solely due to their unanticipated mechanism or is the reaction happening in congruence to the predictable information?

In response to the above stated queries, they have under taken a number of day to day, incessantly compounded surplus waiting-phase profits on the three major asset categories, namely; stocks, reserves bonds, and shared bonds. Koutsoyiannis (2004)

What differentiates this research in contrast to the prior researches of its various types is the investigation of impact of major macroeconomic news on the cooperative allocation of returns in three different financial souks. Surveys and potential data have also been used to dig out the unforeseen mechanism of this information. Furthermore affect of these news bulletins on both the profits generated out of the three categories of assets, as well as their instability and connection is also a part of the analysis.

To understand the flexibility of univariate GARCH model instead of containing the intricacy of the multivariate GARCH model, Dynamic Conditional Correlation (DCC) model by Engle (2002) has been taken under study.

In view of this research they have come up to the conclusion that the information pertaining to the macroeconomic bulletins is considered to have a rather statistically momentous and economically considerable influence over the financial markets of US. Also this significant impact differs to a great extent across asset categories. Therefore it analyzes a multifaceted picture of interaction between the returns on asset in propinquity of public announcements or bulletins. In short a powerful correlation exists amid the actual economy and money markets of the U.S.

With the help of a bivariate GARCH framework, Sarkar, A., et al. (2009), have been able to analyze whether the possibility of positive provisional relationship exists among capital profits and spending or not, even though the existence of absolute correlation is not evident in the case of G7 countries. A monthly statistics of approximately forty years have been considered for the United States and for other countries, quarterly data has been taken into consideration. They have witnessed strong evidence with respect to the existence of positive and considerable uncertain link among advancement in spending increase and capital profits. The hypothesis could not be verified and have been disregarded incase of 6 of the G7 countries as the correlation appears to be constant in nature for them.

In relation to the above they have reached to a conclusion which proposes that the response of the policy incase when the stock market's performance is signifying better results than expected, may need to have a stronger policy than the usual. But when the market conditions turn out to be on the extreme that is either in a positive condition or a negative one, additional effects on the policy shouldn't have an impact by them.In this manner they have worked hard to establish a signifying linkage among capital market and actual economy and what effect does the capital market has on the actual economy.

Another economist, Chauvet, M. (2009), has compiled his work upon establishing an active linkage among capital market variations and the trade cycle. It is of the believe that the movements in the stock market is being reflected by the various positions held up by the participants of the market on the basis of their assessment pertaining to the present condition of the economy. With the help of the on hand financial variables, in this thesis, the researcher has tried to explore the likelihood of envisaging the key rotating spots of the business series. A model has been proposed by Chauvet (2009) that facilitates in generating the predicted key rotating spots of the business series with the help of the trade cycle factor. It also assists in anticipating these predicted turning points pertaining to the trade cycle with the help of the stock market factor. The author; Chauvet, M. (2009) also suggests in this paper, an indicator of the stock market named as the stock market indicator (SMI). With the help of various series of financials, the stock market indicator (SMI) financially assists in the anticipation of essential rotating spots of the business series better in comparison to its individual components. This indicates that the SMI model is by far a better alternative to be used as a tool in anticipating the essential turning points of the trade cycle. Besides that, SMI can also be evaluated by the month end, which highlights the latest information for that particular month of the year. In contrast the CLI model only highlights information pertaining to the preceding month. Therefore the underlying structure suggested by Chauvet, M. (2009), is utilized to study and explore the characteristics of the stock market activities in predicting the trade cycles, particularly the beginning of the recession as a result of which it establishes a strong correlation and one way causal relationship between stock market and the real economy. Monthly data has been taken into consideration by the author from 1954-1994, in studying the economic and financial variables. The name of the economic variables used is: industrial production, manufacturing and trade sales from 1982, non-agricultural civilian employment, and the sum of individual income minus the transfer of payments from 1987. The author has taken into account a number of other variables for the stock market factor, these variables reveal general facts and figures pertaining to the current situation of the financial environment, for example; the amendments in the S&P 500 PE ratio, surplus stock returns, 3-month Treasury bill rate and S&P 500 dividend yield. A two state Markov process has to b followed by each of the factors discussed above. These factors depict various phases of the trade cycle. All of the factors are of the permission to change asynchronously in due course of time.

Brenner, M., et al. (2010) throughout writing this paper have analyzed and examined the deep seated roots that are linked to the financial markets and the real economy. They have also examined the first public news pertaining to information of US macro economy to the short term anticipation and reaction of US stock, Treasury and Corporate Bond. The focus has been primarily placed upon studying the influence of these announcements on not just only on the different levels of those asset returns, but also upon the unpredictability and cooperative changes of those asset returns.

The procedure of how the price arrangement takes place in relation to the macroeconomic news for the three major segments of the market that is - stocks, government bonds and corporate bonds nad has also been explored by them.

While carrying out the research on the underlying variables they have come across 4 important issues:

  • In relation to the first release of the announcements, what impact would these announcements have on the asset returns and the volatility of these asset returns?
  • Does the affect of these announcements differ in their impact in different ways for the various asset classes?
  • Is the current degree of correlation that exists between different asset classes are significantly affected by this news?
  • Is the reaction to the predicted information or the unexpected components of these news driving the impact created by these news releases?

Having the flexibility of univariate GARCH model as opposed to the complex nature of the multivariate GARCH specifications, DCC model has helped resolve the underlying issues mentioned above.

The conclusion reached by Brenner (2010) highlights the significant impact of macroeconomic announcements on the US financial markets. Brenner also highlights that the impact across the asset classes varies to a large extent.

Issues and Challenges

After a thorough analysis of the various studies, we have stumbled upon a number of doubtful results as depicted by the three schools of thoughts. Therefore while conducting this research analysis; we have to sustain the status quo in light of the new challenges that are to be confronted. On the other hand we are also confined to limited access to Indian economic statistics due to inaccessibility of the facts and figures.

In order to cover up every facet of real economy and the stock exchange, the selection of variables have to be carried out in a persistently cautious manner. Having said that, we shouldn't lose track of the fundamental purpose of carrying out this research, which is to figure out the interconnection and informal relationship among the variables under study.

We will be discussing a number of set of issues and objectives in the subsequent chapter, in view of the above mentioned issues concerning the topic under study.


Research Design

The selected research design for this study is Quantitative research technique. Which is the analysis of different aspects that can be easily measurable and quantifiable, such as consumption, shopping, etc? Often used with numeric data. Is that commercial research is to determine and specify the relationships among variables that influence a phenomenon, so you can put in clear cause and effect relationships between these variables. Can be expressed in mathematical language, sometimes in a qualitative way.


The purpose of this study is analyzing the correlation among the stock market and the real economic changes.

The purpose of this study is listed as follows:

  • To estimate the correlation and causality among stock market index, GDP and the real economic variants.
  • To find out the nature of causal association among the stock market and the real economic variants, either it is unilateral or bilateral.
  • Find out the effect of the stock markets and the real economic variants on each other.

Data Selection

Yearly data from 1950-51 onwards to 2007-08 has been taken under study in order to study the variables such as GDP (Gross Domestic Product, bank rate, consumer price index (CPI), domestic savings, gross domestic capital formation (GDCF), and monetary ratio M3 (broad money).

The data for the above mentioned macroeconomic variants has been taken from the Statistics on Indian Economy kept by the Reserve Bank of India (RBI). The data for GDP has also been taken from an on-line data source; the International Financial Statistics kept by the International Monetary Fund.


In light of the pre determined set of objectives to be achieved, various set of techniques have been selected. First and foremost, to carry out the research objectives, evocative statistics like descriptive findings of the dataset are carried out to demonstrate the nature and basic features of the variants studied in this research. Correlation is the second step leading towards the accomplishment of the set of objectives mentioned in this study. It would also support in stating any association between the stock exchange and the macroeconomic variants. Furthermore the formal analysis is carried out by exploring the arbitrary statistical properties of the variables with the help of Unit Root Test, to assess the immobility of the variables. In relation to this study, the most extensively used methods are Augmented Dickey Fuller (ADF) (1979) and Phillips-Perron (PP) (1988) test. If the unit root problem is not evident after examining the variables then Granger causality can be anticipated.

We would now be discussing the two widely considered methods to assess the arbitrary statistical properties of the variants under study.

The first step to implement co-integration procedure is to determine the order of integration for multivariate series Co-integration requires that the series must he non-stationary and integrated of the same order. There are several variations of the unit root test the Augmented Dckey-FuIIer (1979. 1987), Phillip-Perron (1988), and Kwiatkowski. Schmidt and Shin (1992).

The Augmented Dickcy- Fuller (ADE) test has been the most popular test used to check data stationarity in empirical research. This test is applied in higher-order models and models where the error terms are serially correlated. Regression models for ADF is given below:

Where Yt is the series being tested with, α is a constant, t represents a time series, and δ is the lag truncation parameter.

The ADF is achieved under the assumption that a unit root exists, the null hypothesis of unit root (p=0) and the alternate hypothesis states that the series are stationary (p<0). If the calculated statistics is higher than the critical value, we do not reject the null hypothesis, and consider variable is non-stationary; if null hypothesis is rejected, then the variable is considered to be stationary. If it is determined that a series is stationary, the co-integration is not appropriate, and another technique such as Least Square Model can be used.

Granger Causality Test

The essence of VAR models is as follows: We propose a system of equations, with many equations as a series to analyze or predict, but in which no distinction between endogenous and exogenous variables. Thus, each variable is explained by the delay of itself (as in an AR model) and lags of other variables. Is set then a set of autoregressive equations or, if you do so, a vector autoregressive (VAR).

The general expression of VAR model would be given by the following specification:

where t is a vector g with the object of prediction variables (call them explained), xt is a vector of k variables that explain in addition to the above, the alpha and beta coefficients are matrices of coefficients to be estimated, and epsilon is a vector of disturbances random (one per equation), each of which individually satisfies the assumption of white noise (homoskedasticity and no autocorrelation), and including the assumption of homoskedasticity meet international equations.

This study determines whether there are causal links in the direction of Granger between stock indexes and key macroeconomic aggregates. If these links exist, it is particularly interesting to determine in which direction they will: is it for clues that "cause" aggregates or is it vice versa? The direction of causation may give rise to new implications in the world of finance for example.

Indeed, if we can demonstrate that macroeconomic aggregates "cause" changes in market indices, then it is obvious that the analysis of these aggregates in determining policy investment on the derivatives markets may be useful. In another vein, it would also be interesting to get the opposite result to know whether stock indexes, which "causes" the main aggregates macroeconomic.

In this case, it would be interesting to see how extent the central authorities could benefit from information provided by changes in market indices to determine their own fiscal policies or monetary. In all cases, it is extremely exciting to engage in this type of link Granger causality depending on such variables as from our extensive research, nothing has been published about it. The track is still probably totally blank and we hope to obtain conclusive results to be worthy of our role as pioneers in this field.



In order to explore the effect of macroeconomic variable on the stock market in India, it is important to understand the economic environment in which the stock market exists. This chapter provides a brief overview of the economic structure of India, exploring the role of consumer price index in the economy as well as some economic indicators such as GDP, Bank rate, Domestic savings, Gross Domestic Capital Formation (GDCF), and Broad money or M3.


Relationship between Stock Market and Macroeconomic Variables in India 1

Relationship between Stock Market and Macroeconomic Variables in India 1

The above sequence charts show that a cyclic and an increasing trend is present in the data set. So first we have to minimize the trend of the data set by using time series techniques then we apply unit stationarity test on the selected data set.

Descriptive Statistics


Variable s

























































































From above table of descriptive statistics it is observed that variation is present in the dataset as the value of standard deviation is high.






Domestic Savings

















































From above Correlation matrix table it is observed that the value of pearson correlation is close to 1so it represents a strong association among the selected macroeconomic variables. It can be said that variation in one variable may affect the other variable as direct association is present among the variables.

StationarityandCausality Analysis

In the previous section, we discussed the variables that will be used in studying the association between stock market prices and macroeconomic variables, and in this section we will examine the time series properties of the data.

In order to implement cointegration between the time series. We need to pretest the variables for their order of integration. It is necessary to show that they integrated in the same order.

For each of the variable, the Augmented Dickey-Fuller (ADF) unit root test was used with constant and with constant and time trend for all variables in their levels and then in their first difference using a low lags based on the Schwarz Information Criterion (SIC). In this test, the null hypothesis Ho: α=0 is that the variable under study contains a unit root against the alternative that it does not contain a Unit root. Therefore, the failure to reject the null hypothesis means that the variable is non-stationary, while the rejection of the null hypothesis reflects the absence of a unit root, which means that the variable is stationary, if the null hypothesis is not rejected for the variable in its level and rejected for the variable in its first difference, then we can conclude that the variable is integrated I (1). if the null hypothesis is rejected For the variable in its level then it can be said the variable is stationary I (0).

The Auginerned Dickey-Fuller test results are shown in Table 4.3 and 4.4 with the constant and in Table 4.3 and 4.4 for the case where we have constant and time trend. Comparing the ADF t-values of the level series with 1 and 5% critical value, which is reposted at the bottom of each table, the results suggest that all market indices as well as macroeconomic variables are I (1), where the first differences arc integrated of order zero I(0). We fail to reject the null hypothesis of the existence of a unit root in levels, but reject the same null hypothesis in the first difference of the series.

Table4.5:GrangerCausality Test

Pairwise Granger Causality Tests

Date: 03/28/11 Time: 15:00

Sample: 1961 2009


Lags: 2


Null Hypothesis:




CPI does not Granger Cause GDP




GDP does not Granger Cause CPI




Bank rate does not Granger Cause GDP




GDP does not Granger Cause Bank rate




GDCF does not Granger Cause GDP




GDP does not Granger Cause GDCF




Broad money does not Granger Cause GDP




GDP does not Granger Cause Broad money




Bank rate does not Granger Cause CPI




CPI does not Granger Cause Bank rate




GDCF does not Granger Cause CPI




CPI does not Granger Cause GDCF




Broad money does not Granger Cause CPI




CPI does not Granger Cause Broad money




The test of Granger causality confirms the results of the estimation model VEC, only the rate of GDP growth because changes in the CPI underlying with a probability associated with the F-statistic of 0.05 below the threshold of 10%. All other assumptions of non-causality with the index of underlying price are accepted at the 10%. Regarding the causality of changes in CPI with the rate of GDP growth and with changes in the exchange rate, the test confirms the null hypotheses of no causality, which support the conclusion of the estimation of this model: the fluctuations in CPI, Bank rate, Domestic savings, Gross Domestic Capital Formation (GDCF), and Broad money or M3 does not generate second-round effects via the rate of GDP growth or fluctuations in exchange rate rupees dollar


Stock markets play an important role in the financial sector of each economy. A healthy stock market can promote economic growth by stabilizing the financial sector and providing an important investment channel that contributes to attract domestic and foreign capital. Fama (1981) showed that there is a strong association between stock prices and industrial production as well as gross national product. In related work, Chang and Pinegar (1989) also concluded that there is a close association between the stock market and the domestic economic activity, despite the importance of stock markets in the world's economies, stock markets remain unstable. For example, the famous 1929 market decline in the United States prior to the great depression. Other examples include the share market crash in the United States in 1987, which sent shock waves throughout the world's financial market, and, more recently, the crises of the Southeast Asian stock markets in 1997. These crashes and accompanying swings have raised the question what, if anything can be done to moderate volatility in stock prices. A debate has been established concerning the design of monetary policy and possible intervention actions by the central banks to prevent a stock market crisis (Dhakal, Kandil, and Sharrna, 2003).

An understanding of the determinants of stock market movement is an essential goal, not only for economists or financial analysts, but also of government offices. Most of the empirical studies regarding the determinants of stock market movements have been centered on two contradicting theories: the quantity theory of money and the efficient market hypothesis.

The quantity theory of money has played a large role in determining the association between money supply and various economic variables. On the other hand, in the efficient market hypothesis, new information is rapidly incorporated into the prices of assets held in the market, so current asset prices reflect all currently available information.

March 2008 fiscal year rate of about 9 percent. 6.7 percent growth rate is relatively better because being told the financial analysts expressed fears of financial crisis bad economy and growth rates were estimated to be between 6 and 6.5 percent were expressed. March quarter growth estimate of 5.2 percent rather than 5.8 was.

Is believed that the economy has passed the worst phase and the reason that the recent interest rate cuts by the Reserve Bank is not that blew life into the economy can be. Indications are that the estimated time before there are signs of improvement in the Indian economy.

Economic growth projected over the effect of having appeared on the stock exchange and the Bombay Stock Exchange CPI index climbed 370 points reached 14,667. Last quarter of the fiscal year ended in 2009, 5.8 percent growth rate is estimated.

India's gross domestic product of financial derivatives can be decomposed in this sector the impact of a brief explanation. In the short term to promote economic growth and the country's international trade, these investments. This is actually a (usually through mergers and acquisitions) International Bank shed light as the leading consumer finance imports, especially automobiles, mobile phones and other consumer electronics products quickly exactly the same entrance. India in 2000, less than one million mobile phone users have up to 60 million mobile phone users. In the mobile communications companies are now part or all of the foreign investment, and Japanese car manufacturers in India has doubled in the last five years of automobile production. In oil imports, oil imports will increase low-cost expansion to cover the deficit increase. This increase in consumption should lead to inflation in the short term, it is through our research that. Similarly, exports compared to faster import growth means that, short-term foreign direct investment is not in the country's export earnings improved significantly. Foreign direct investment, in this case, it is possible to replace domestic investment.

Between human capital and long-term negative correlation between the technology without any significant foreign investment from the overflow of the indicators of the presence of impact. According to the Palestinian side of the technical level of the staff did not keep up with financial derivatives, growth rate of the rich scientific and technological content. During 1992-2006, investment policy reforms and foreign direct investment stage, overall labor productivity growth rate of 1.7 per cent a moderate flow increase. In addition, foreign investment in India, especially in recent years has been concentrated in high-tech capital-intensive services, such as oil and gas exploration, financial services and telecommunications sectors do not create many jobs. In the main labor-intensive agriculture, mainly unskilled and semi-skilled service sector employment, labor skills, traffic has not changed much. Thus, economic growth reflects the modern and the traditional differences between industries.

Some economists believe that a good policy by increasing the incentives and punishment policy errors, in order to promote the free flow of transnational capital, more stringent macroeconomic policies to reduce the frequency of wrong decisions. This requires observation, if this has been the situation in India.

The first answer is a qualified affirmative. The Government has reformed the procedures related to business and industry to simplify regulations and reduce the bureaucratic obstacles. The results of India, more business than some other countries in the region friendly, although there is still much work to do.

On the contrary, the consequences for the general public are so useful. Foreign M & A tends to focus on juicy, immediately profitable, but the largest in the industry for the country's long-term investment sector is often little concern about potential. The Government is going through access to its cheap and abundant hydropower and thermal power potential foreign investment difficult and expensive, but soon the oil-based power plants to install the proposition not come easily. Similarly, the Bank has attracted a lot of the credit boom of foreign direct investment inflows, especially since the early 21st century, as more and more consumers, the bank interest rate differential more than seven percent, and most of the regional economy, such as textiles, agriculture, and transportation investment still missing. This foreign investment has a positive economic impact, but not many people can benefit. Not much work has been produced, nor is it an ordinary life, raise standards. Who is to fight inflation by the consumer boom is the rise in the majority of the poor poorer. In a country, a window less than a dollar a third of the population lives, this non-job creation, capital-intensive investment, the gap between rich and poor countries to further expand the have-nots name of the poverty line. There are also some good examples, foreign investment, profit repatriation and off investors in the first year the total investment.

Another important finding is that so far the causal association between exports, foreign direct investment and GDP, we are in the sequence diagram graph shows the association between cause and effect between the time series analysis of these three variables may does not produce a useful general rule economic policy information.

Finally, we can identify that current literature tends to emphasize as foreign direct investment to GDP growth, the development of individual capital or financial contributions. individual capital, and for that matter, financial development, may be important to estimate a regression or economic growth, the impact of foreign direct investment flows, is considered by Borensztein, De Gregorio, and Lee (2008) and horses Shi and Lensink shown determination (2003). Though, the rationale of this paper is not to estimate such a side effect, which inevitably caused a problem of the endogenous variables. Instead, we aim in this paper is to test the foreign direct investment and gross domestic product, the causal association, as well as export. Therefore, we can also indicate that our sheet data examination also showed that the predictable foreign direct investment in gross domestic product resulting openly or ultimately, throughout exports, therefore, our analysis shows that exports are likely is a fine alternative, if not corresponding, individual and capital or foreign direct investment and GDP association between financial developments.

Research on multiple foreign stock market prices and macroeconomic variables

One of the most comprehensive studies into the dynamic linkage of stock prices and macroeconomic factors for emerging economies was conducted by Muradoglu, Taskin, and Bigan (2000). Muradoglu et al. noted past research had provided evidence for the effect of a number of macroeconomic variables on stock market returns which were assumed to be unidirectional from macroeconomic variables to stock returns. Exchange rates had been shown to influence stock prices through the terms of trade effect where the depreciation of domestic currency increased the volume of exports, leading to higher cash flows and stock prices for domestic companies, provided the demand for export goods were elastic. Also, the association between inflation and stock returns has proven to be more controversial, with empirical studies showing a negative association between the two, through the effect of inflation on interest rates and the discount rate. Given an increase in inflation is expected to increase the nominal risk-free rate, this in turn will raise the discount rate used in valuating stocks, leading to inverse stock valuations if cash flows do not adjust in the same direction. Lastly, Muradoglu et al. noted previous research had shown the level of real economic activity, reflected in a production index, was expected to have a positive impact on stock prices, through increased future cash flows.

As earlier research into the linkages of stock market returns and macroeconomic variables had focused on one country versus a group of countries and assumed the respective relationships to be unidirectional, Muradoglu et al. focused their study on the causal association between macroeconomic variables and stock market returns for 19 emerging markets (defined by the World Bank's International Finance Corporation (IFC) index as any market belonging to low- and middle-income, less-developed countries with the implication they all have the potential for development) and tested for the direction of the underlying causal association using monthly time series data. The IFC index attempts to cover 70 percent of market capitalization and is calculated for all of the 19 emerging markets in a similar fashion, making international comparisons possible. For each country (Argentina, Brazil, Chile, Colombia, Greece, India, Indonesia, Jordan, South Korea, Malaysia, Mexico, Nigeria, Pakistan, Philippines, Portugal, Thailand, Turkey, Venezuela, and Zimbabwe) the stock returns (R), exchange rates (FX), and interest rates (I) were assumed to be linear in a set of local and global information variables, whereas inflation (INF) and industrial production (PROD) were assumed to be linear in a set of local information variables only.

The global information variable was the return on the S&P 500 index (SNP), which represents the world market portfolio and controls for the degree of market liberalization. Local information variables arc returns on country indices (R), exchange rates (FX) interest rates (I), inflation (INF), and an industrial production index (PROD). Both the local stock market returns (R) from the IFC index and the S&P 500 index (Datastream) were calculated using the first-order differencing of their logarithmic levels. The data for the macroeconomic variables were obtained from the International Monetary Fund (International Financial Statistics or IFS database) and are the first-order differences of logarithmic values to account for growth rates, except for interest rates. Interest rates (I), in percentages, were obtained from the monthly computed value of time deposit rates used by each respective country and the inflation (INF) variables were computed from the consumer price index of each country. The exchange rates (FX) were defined as the national currency per special drawing rights (SDR) and captured the effect of a basket of currencies on the stock market, instead of a single foreign currency.

Real economic activity (PROD) was represented and measured by the industrial production index of each country and as a measure of general economic activity which proxies for the gross

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