Over the past few decades, the interaction of share returns and the macroeconomic variables has been a subject of interest among academicians and practitioners. It is often argued that stock prices are determined by some fundamental macroeconomic variables such as the interest rate, the exchange rate and the inflation. Some evidence from the financial press indicates that investors generally believe that monetary policy and macroeconomic events have a large influence on the volatility of the stock price. This implies that macroeconomic variables can influence investors' investment decision and motivates many researchers to investigate the relationships between share returns and macroeconomic variables. According to Oberuc (2004), the economic factors which, usually associated with stock prices movement and being considered greatly by researchers are dividend yield, industrial production, interest rate, term spread, default spread, inflation, exchange rates, money supply, GNP or GDP and previous stock returns, among others.
In the financial literature, numerous prior studies focus on examining this relation for primarily industrialized countries but less attention to non-industrialized countries. This thesis contributes to the literature by quantitatively analyzing the dynamic linkage of six key macroeconomic variables (interest rate, money supply, inflation, industrial production, national income, and exchange rate) and the stock returns for four emerging ASEAN4 stock markets (Indonesia, Philippines, Thailand, and Vietnam) over the period 2001:1 - 2010:12. The stock market return represents the change in stock market index. Specially, the study strongly focuses on the effects of interest rate, exchange rate and inflation on the stock prices. In addition, the study also pays attention to the impact of the financial crisis of 2008 on the stock prices of the region.
Research questions:
Is stock exchange performance a valid indicator that reflects the economic conditions of the country?
Can macro-economic indicators be used to predict stock exchange prices in ASEAN countries?
Literature Review:
The relationship between stock prices and macroeconomic variables is well illustrated by theoretical stock valuation models such as Dividend Discount Model (DDM), Free Cash Flow Valuation, and discounted cash flow or Present Value Model (PVM). According to the models, the current prices of an equity share is approximately equal to the present value of all future cash flows; thus any economic variable affecting cash flows and required rate of return in turn influences the share value as well. Chen, Roll and Ross (1986), having first illustrated that economic forces affect discount rates, the ability of firms to generate cash flows, and future dividend payouts, provided the basis for the belief that a long-term equilibrium existed between stock prices and macroeconomic variables.
Most of the empirical studies based on the Arbitrage Pricing Theory (APT) developed by Ross (1976), where multiple risk factors can explain asset returns, linking the state of the macroeconomy to stock market returns, are characterized by modeling a short-run relationship between macroeconomic variables and the stock price in terms of first differences, assuming trend stationarity. For a selection of relevant studies, see Fama (1981, 1990), Fama and French (1989), Schwert (1990), Ferson and Harvey (1991) and Black et al. (1997). In general, these papers found a significant relationship between stock market returns and changes in macroeconomic variables, such as industrial production, inflation, interest rates, the yield curve and a risk premium.
Humpe and Macmillan (2009) using US and Japanese data over last 40 year found that both US and Japan stock prices are negatively correlated to a long term interest rate and inflation, positively influenced by the industrial production. Yet the money supply had an insignificant influence over the US stock price but positively related to JP stock price.
Orawan R. and Subhash C. Sharma (2007) report the negative relationship between US stock prices and long-term interest rate, and a positive relation between US stock prices and the money supply, industrial production, inflation, the exchange rate and short-term interest rate by using monthly data (1975-1999).
Data and Methodology:
Monthly time series data across four ASEAN countries are used in exploring the relationship between the macroeconomic factors and stock prices of these countries. The data were all obtained from International Financial Statistics and local Central Bank. Stock prices are measured using indices for the national stock exchange, specially, Jakarta Composite Index for Indonesia (JCI), the SET Composite Index for Thailand (SCI), Manila Composite Index for Philippines (MCI), and VN Index for Vietnam (VNI).
To analyze the relationship between macroeconomic factors and the stock prices, a variety of tests is applied:
Panel unit root test: applying the augmented Dickey-Fuller (ADF) test to determine the stationarity of data;
Panel cointegration test: using maximum likelihood approach of Johansen (1988) and Johansen and Juselius (1990) to investigate the long-run relationships among the variables;
Granger causality test: analyze the causal order in VAR and VECM model. In addition, Variance decompositions (VDC) method is used to gauge the consistency of causality test.
References (typically):
Fama E. F. & Schwert, W.G., 1977, "Asset returns and inflation", Journal of Financial Economics, 5, pp. 115-146.
Fama, E. F. 1981, "Stock returns, real Activity, inflation and money", The American Economic Review, 71(4), pp. 45-565.
Fama, E. F. & Gibbons, M. R. 1982, "Inflation, real returns and capital investment", Journal of Monetary Economics, 9, pp. 297-323.
Fama, E. F. 1990, "Stock returns, expected returns and real activity", Journal of Finance, 45(4), pp. 1089-1108.
Fama, Eugene, 1970, "Efï¬cient capital markets: a review of theory and empirical work", Journal of Finance, 25, pp. 383-417.
Humpe, A. and Macmillan, P. 2007, "Can macroeconomic variables explain long term stock market movements? A comparison of the US and Japan", Centre for Dynamic Macroeconomic Analysis Working Paper Series.
Johansen, S. 1988, "Statistical Analysis of Cointegration Vectors", Journal of Economic Dynamics and Control, 12, pp. 231-254.
Johansen, S. 1991, "Estimation and Hypothesis Testing of Cointegrating Vectors in Gaussian Vector Autoregressive Models", Econometrica, 59, pp. 1551-1580.
Johansen, S. & Juselius, K. (1990), "Maximum likelihood estimation and inference on cointegration with application to the demand for money", Oxford Bulletin of Economics and Statistics 52, 169-210.
Oberuc, R. E. 2004, "Dynamic Portfolio Theory and Management: Using Active Asset Allocation to Improve Profits and Reduce Risk", Mc-Graw Hills, U.S.
Ratanapakorn, Orawan and Sharma, Subhash C. 2007, "Dynamic analysis between the US stock returns and the macroeconomic variables", Applied Financial Economics, 17:5, 369-377.
