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ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009.

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ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. 14

STOCK MARKET AND MACROECONOMIC VARIABLES: EVIDENCES FROM LITHUANIA
Donatas Pilinkus
Kaunas University of Technology, Lithuania, pilinkus@pilinkus.com

Abstract
The stock market has been historically viewed as a reliable instrument to indicate economic processes. However, contemporary papers reveal the controversy of the issue. A clear understanding of stock market determinants is vital for investors, regulators, and academic researchers. Therefore, future researches are required to further explore this issue. The present paper analyzes relationships between a group of macroeconomic variables and the Lithuanian stock market index, i.e. OMX Vilnius index. The objective of this paper is to investigate whether stock prices may serve as a leading indicator for macroeconomic variables in Lithuanian economy or a group of macroeconomic variables may serve as a leading indicator for stock returns in Lithuania. Granger causality tests have been employed to estimate the relationship between the OMXV index and 40 macroeconomic variables depicting the health of Lithuanian economy from December 1999 to March 2008. The research reveals that some macroeconomic variables (e.g., GDP deflator, net export, foreign direct investment, etc.) lead Lithuanian stock market returns, some macroeconomic variables (e.g., GDP, material investment, construction volume index, etc.) are led by the OMXV index and, finally, some macroeconomic indices (e.g., money supply, payment balance, etc.) and the stock market returns Grangercause each other. Keywords: Lithuanian economy, stock market, Granger causality, macroeconomic variables.

Introduction
The relationship between stock markets and macroeconomic forces has been widely debated in the finance and macroeconomic literature (Fama, 1981; Friedman, 1988; Keran, 1971, Nelson, 1976). Most of such studies suggest that financial and macroeconomic variables influence stock prices across a variety of markets and time horizons (Been et al., 1990; Bulmash & Trivoli, 1991; Campbell, 1987; Cochrane, 1991; Fama & French, 1989; Golsten et al., 1993, Ibrahim, 1999; Maysami & Koh, 2000; Mukherjee & Naka, 1995; Poon & Taylor, 1991). A number of studies, for example, modelled relationships between US stock prices and real economic activity (Abdullah & Hayworth, 1993; Chen et. al., 1986; Fama, 1981; Geske & Roll, 1983; Lee, 1992), some studies focused on investigating the relationship between the UK stock market and macroeconomic factors (Cheng, 1995; Poon & Taylor, 1991), other researchers attempted to find the relationships in Canada (Darrat, 1990), in Japan (Hamao, 1988; Mukherjee & Naka, 1995), in Singapore (Maysami & Koh, 2000; Maysami et. al., 2004; Ta & Teo, 1985), in India (Agrawalla & Tuteja, 2007; Padhan, 2007), in Malaysia (Ibrahim, 1999), in European countries (Ansotegui & Esteban, 2002; Asprem, 1989; Dritsaki & Adamopoulos, 2005; Gjerde & Saettem, 1999; Panetta, 2002; Tsoukalas, 2003; Wasserfallen, 1989). The outcomes of all these studies suggest that, with minor degrees of variation, fundamental macroeconomic dynamics are indeed influential factors for stock market returns. However, several studies debate the existence of any significant relationships between stock market performance and macroeconomic variables, for example, efforts of Culter, Poterba, and Summers (1989) to relate the value of specific macroeconomic variables to stock returns generally failed to identify robust effects; studies of Martinez and Rubio (1989) as well as of Gjerde and Saettem (1999) have not implied a significant relation between stock returns and macroeconomic factors; Schwert (1989) tested the effect of domestic (the United States) macroeconomic variables on stock volatility and found weak evidence that such factors could predict stock market returns which are inherently volatile; Fung and Lie (1990) argued that macroeconomic factors can not be reliable indicators for stock market price movements in the Asian markets because of the inability of stock markets to fully capture information about the change in macroeconomic fundamentals; Richards (1996) detected little indication of increased short-term predictability and volatility in stock returns; Allen and Jagtianti (1997) pointed out that interest rate sensitivity to stock returns has decreased dramatically since the late 1980’s and the early 1990’s because of the invention of interest rate derivative contracts used for hedging purposes. The controversy of the issue requires further exploring the subject. Thus, the objective of this paper is to evaluate whether stock prices may serve as a leading indicator in a small open economy taking into consideration evidences from Lithuania. The research methods applied in this paper embrace the logical

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They concluded that a cointegration relation indeed existed and the stock prices contributed to this relation. market capitalisation and consumer price index) during 1992-2001 in Thailand. al. 1983. Allen and Jagtianti. though the type and magnitude of the associations differed depending on the country’s financial structure. the comparison and generalization method. Cheung & Ng. changes in short. Maysami & Koh (2000) examined such relationship in Singapore and found that inflation. Mukherjee & Naka. This paper will analyse evidences from Lithuania expecting the findings to give some more significant insights despite of one limitation. 1998. al. money supply. 2007. Emerging stock markets have been identified as being at least partially segmented from global capital markets. Brailsford. Poon & Taylor. The data are monthly and extend from the December of 1999 to the 885 . 1990) or on a group of several countries (Asprem. 1992. 1995. 14 analysis and synthesis of scientific literature.. the statistical grouping method. Malaysia and Thailand. 1989. Schwert. more material markets such as the US. 1991. Lee. 1989.and long-term interest rate and variations in exchange rate formed a cointegrating relation with changes in Singapore’s stock market levels..ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009. 1986. Japan. 1996.. Mukherjee & Naka (1995) applied Johansen’s (1998) vector error correction model to analyze the relationship between the Japanese stock market and exchange rate. El-Wassal.. Gjerde & Saettem. Japan and South Korea. Peiro. priceearning ratio. Maysami & Koh. and the Granger Causality tests. 1992. has been done focusing either only on the US economy (Abdullah & Hayworth. 2005. Through the employment of Hendry’s (1986) approach.. 1989. Chen et. exchange rate and real activity. The results confirmed the influence of macroeconomic variables on the stock market indices in Hong Kong and Singapore. Fung & Lie. Lin et. real economic activity. & Hooper (1999) detected little evidence of commonality when emerging markets are considered collectively. Geske & Roll. and call money rate. 1986. a focus has been laid on evidences from Lithuania. Islam & Watanapalachaikul (2003) showed a strong. money supply growth. 14 ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. al. There are some studies negating the existence of any significant relationships between stock market performance and macroeconomic variables (Culter et. Chen et. 1999.. significant long-run relationship between stock prices and macroeconomic factors (interest rate. Binswanger. al. inflation. inflation. Cheng. The stock market crash could be an example in which stock prices falsely predicted the direction of the economy: instead of entering into a recession which many were expecting. Schwert. Disagreements in theory inspire to continue the research in this field. Lee.e. After investigating the degree of commonality in exposure across emerging stock market returns using a principal components approach Bilson. 1983). Singapore and others (Abdullah & Hayworth. 1993. 1989. 2006. They found moderate evidence to support this hypothesis. Choi et. however. Fama. 1999. 1985). i. Wasserfallen. long-term government bond rate. 1990. The literature is very rich in developed. al. bonds price. it has been argued that local risk factors rather than world risk factors are the primary source of equity variations in these markets (Bilson et. Much of the related research that addresses the empirical link between the stock market prices and the real economy. 2001. along with a dummy variable to capture the impact of the 1997 Asian financial crisis. the strength of the present paper lies in the fact that it is attempted at finding the relation between the stock market returns and even 40 macroeconomic variables while all previous studies have mainly focused on less then 10 macroeconomic fundamentals. considerable commonality was proven to exist. Theoretical underpinnings The relationship between stock prices and macroeconomic variables has been the topic for academic researchers and practitioners. 2000. 1981. Maysami et. al. Fama. At the regional level. As a consequence. 1995. Martinez & Rubio. Geske & Roll. money supply. This will help to grasp a better overall understanding and it will contribute to a more in-depth investigation of the current issue. Pearce (1983) noticed that the stock market has previously generated ‘false signals’ about the economy and should not be relied on as an economic indicator. the analysis has been carried out only for one country. 2002) analyzed the influence of interest rates. However. Data and research methodology Seeking to identify the relationship between stock prices and macroeconomic variables. al. Ta & Teo. foreign exchange rate. Hamao. 1988. the economy continued to grow for several years (Pearce. Richards. 1999). 1997). 2001b. 1993. which is measured either by the real industrial production or the real gross domestic product (GDP). 1989). Siliverstovs & Doung. UK. 2004. the systematic analysis of statistical data. 1996. Maysami & Sim (2001a. 1981. 1983.

index of own-account construction work carried out within the country (IOCW). etc. The correlation between a series and its lagged values are assumed to depend only on the length of the lag and not when the series started. Granger (1969). have great influence on its variations. balance of payments (BP). retail trade index (RTI). In general. we will conduct our analysis by picking different lag lengths varying from 2 to 24. general government revenue (GGR). import volumes (Im). He argued that there is an interpretation of a set of tests as revealing something about causality. Time series analysis must be based on stationary data series for drawing useful inferences.ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009. one month Vilnius interbank offered rate (VILIBOR1M). general government expenditure (GGE). This index indicates stocks which are quoting in the securities exchange of Vilnius. changes in prices of industrial production (CPIP). market prices standards and dynamics. general government debt (GGD). Thus. Figure 1 demonstrates that the assumption of stationary data would be violated if we analyzed OMXV index values as they are since there is a clear trend in the data series. In order to have a more detail result. government final consumption expenditure (GFCE). After selecting the Granger-causality view in EVIEWS software it is required to select the number of lags to use in the test regressions. index of capital goods (ICG). gross domestic product (GDP). net export (NEx). general government financial balance (GGFB). average number of hours actually worked per employee per month (AHW). foreign direct investment (FDI). manufacturing index (MI). the difference between one year and overnight Vilnius interbank offered rates(VILIBOR1Y_1N). it may be assumed that dynamics of OMXV index reflect the overall country’s economical situation quite reasonably. The variable which is used to represent stock price movements is a value of the OMX Vilnius (OMXV) index on the last business day of the month. three months Vilnius interbank offered rate (VILIBOR3M). overnight Vilnius interbank offered rate (VILIBOR1N). since the theory is couched in terms of relevance of all past information. generate forecasts or model simulations. i. Empirical findings: application of Granger causality tests Before undertaking the Granger-causality procedure it is relevant to determine whether there is a trend in our time-series data. which can quickly and efficiently manage the data. 14 ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. “City Service”. This property is known as stationarity and any series obeying this is called a stationary time series. index of nondurable consumer goods (INCG). It is a technique for determining whether one time series is useful in forecasting another. The procedure employed for testing the relationship or statistical causality between stock prices and the macroeconomic factors is the direct Granger-causality test proposed by C. gross domestic product deflator (GDPd). The largest Lithuanian enterprises. export volumes (Ex). exchange rate of the Litas against the US dollar (ExR). construction price index (CPI). money supply in a narrow sense (M1). money supply in a broader sense (M2). “Klaipedos Nafta”. In our case we will attempt to measure if fluctuations of OMXV index might be reasonable in forecasting changes in real economic activity expressed by the above listed variables and vice versa.e. six months Vilnius interbank offered rate (VILIBOR6M). such as “TEO LT”. harmonised consumer price index (HCPI). index of energy products (IEP). Broadly speaking a data series is said to be stationary if its mean and variance are constant (nonchanging) over time and the value of covariance between two time periods depends only on the distance or lag between the two time periods and not on the actual time at which the covariance is computed. final consumption expenditure (FCE). 886 . index of durable consumer goods (IDCG). “Ukio bankas” and many others. investment in tangible fixed assets (ITFA). employment rate (ER). granted permits for new residential buildings (GP). perform econometric and statistical analysis. 14 March of 2008. producer price index of industrial production (PPI). from 2 months to 2 years. The Granger causality method has been carried out by employing the software package of EVIEWS. index of intermediate goods (IIG). unemployment rate (UR).J. The macroeconomic variables incorporated in the empirical analysis together with their abbreviations in the brackets are as follows: gross external debt (GED). it is better to use more rather than fewer lags. one year Vilnius interbank offered rate(VILIBOR1Y).

Figure 2 displays how OMXV index values have changed after differentiating them at the second level. 1999. al. 2005). gross 887 . OMXV 120 80 40 0 -40 -80 -120 -160 00 01 02 03 04 05 06 07 Figure 2. gross external debt. The accepted significance level is 95%. Dritsaki & Adamopoulos. We see that some macroeconomic variables Granger-cause stock market prices (for example. arrows pointing to the bottom of the table (↓) indicate that a particular macroeconomic variable is Granger-caused by the OMXV index. It is consistent with most studies where Granger-causality tests have been applied (Agrawalla & Tuteja. 14 OMXV 600 500 400 300 200 100 0 00 01 02 03 04 05 06 07 Figure 1. 2003. OMXV index values from 1999:12 to 2008:03 In order to have the data stationary we will apply differentiation for all time series (OMXV index and macroeconomic variables). Arrows in Table 1 indicate there is a causality relationship between a number of macroeconomic variables and stock market returns in Lithuania. Ibrahim. OMXV index values differentiated at the second level The final results of the Granger-causality tests have been summed up in Table 1 (lag lengths vary from 2 to 24). Vuyyuri. 14 ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. and. 2007. 2003. Karamustafa & Kucukkale. 1991. finally. 2000. Nishat & Shaheen. 1992. 2005. 1995. Arrows pointing to the upper part of the table (↑) indicate which macroeconomic variable Grangercauses the OMXV index. Comincioli. Lee. The converted data is now acceptable for accomplishing the Granger-causality tests. Since the differentiation at the first level is not enough for some data series we differentiate all data at the second level and convert all non-stationary data to stationary. Nasseh & Strauss. two-ended arrows (↨) reflect bi-directional Granger-causality. 2004.ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009.. 2000. Fifield et. Mahdavi & Sohrabian. Tsoukalas.

Im. money supply (M1 & M2). Vuyyuri. GGE are Granger-caused by OMXV index. import volumes. IIG. 2007). Ibrahim. 2005. average number of hours actually worked per employee per months. they can be used to predict stock market price fluctuations. Vuyyuri. PPI. index of intermediate goods. GP. stock market returns 888 . To sum up our results. 14 ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. Padhan. while a group of other macroeconomic factors such as GDP. construction price index. 2005). and some macroeconomic variables under the investigation have no Granger-causality relations with stock market returns in Lithuania (index of energy products. Nishat & Saghir. we see that such macroeconomic variables as GED. gross domestic product. employment rate.e. The variety of causality relations may be explained by the fact that our analysis incorporates 40 macroeconomic variables while other studies usually take only few. there is a bi-directional causality in some cases (for example. 2003. etc. unemployment rate. general government debt). we see that lag lengths have some influence on the Granger-causality relations.). etc. i. For example.e.). AHW. etc. 1999. INCG. IOCW. i. 2001. GGR. GGFB. gross external debt Granger-causes OMXV index. exchange rate of the Litas against the US dollar. Mukherjee & Naka. ICG. balance of payments. 1981. 1995.e. investment in tangible fixed assets. export volumes. Results of the Granger-causality tests: lag lengths vary from 2 to 24 Variable GED GDP GDPd PPI ICG Im IDCG GP M1 M2 BP RTI FCE CPIP IOCW INCG FDI IIG MI AHW GFCE GGFB GGR GGE NEx 2 ↑ 3 ↑ ↓ ↑ ↑ ↓ ↓ ↓ ↑ ↓ ↓ ↓ ↓ ↓ 4 ↑ ↑ ↓ ↨ ↑ ↓ ↓ ↨ ↓ ↑ ↓ ↑ ↨ ↑ ↑ ↓ ↑ ↨ ↑ ↨ ↨ ↑ ↑ ↓ ↓ ↓ ↓ ↓ ↓ ↑ ↓ ↓ ↑ ↓ ↓ ↓ ↑ ↓ ↓ ↑ ↓ ↑ ↓ ↨ ↓ ↑ ↓ ↓ ↨ ↑ ↨ ↓ ↑ ↓ ↨ ↓ ↑ ↑ ↓ ↑ ↓ ↓ ↑ ↓ ↑ ↨ ↓ ↑ ↓ ↓ ↑ ↓ ↑ ↑ ↓ ↑ ↓ ↓ ↑ ↓ ↑ ↑ ↓ ↑ ↓ ↓ ↨ ↑ ↨ ↑ ↓ ↑ ↓ ↨ ↨ ↑ ↨ ↑ ↓ ↑ ↓ ↨ ↓ ↨ ↨ ↑ ↓ ↑ ↓ ↨ ↓ ↑ ↓ ↑ ↑ ↓ ↑ ↓ ↨ ↓ ↑ ↨ ↑ ↓ ↑ ↓ ↓ ↓ ↑ ↑ ↑ ↓ ↓ ↨ ↓ ↑ ↓ ↑ ↑ ↓ ↓ ↓ ↓ ↑ ↑ 5 ↑ ↑ ↑ ↓ ↓ ↨ ↓ 6 ↨ ↑ ↨ ↓ ↓ ↓ ↓ 7 ↑ ↑ ↑ ↨ ↓ ↨ ↨ ↨ 8 ↨ ↑ ↨ ↓ ↨ ↨ ↨ 9 ↑ ↑ ↑ ↑ ↨ ↨ ↨ ↓ ↨ 10 ↑ ↑ ↑ ↑ ↑ ↨ ↑ ↨ ↨ 11 ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↨ ↨ ↑ 12 ↑ ↑ ↑ ↑ ↑ ↨ ↑ ↨ ↨ ↑ OMXV Lags 13 14 15 ↓ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↨ ↨ ↨ ↑ ↑ ↑ ↨ ↨ ↨ ↨ ↨ ↨ ↑ ↑ ↑ 16 ↑ ↓ ↑ ↑ ↑ ↑ ↨ ↑ ↨ ↨ ↑ 17 ↑ ↑ ↑ ↑ ↨ ↨ ↑ ↨ ↨ ↑ 18 ↑ ↓ ↑ ↑ ↑ ↨ ↨ ↓ ↨ ↨ ↑ 19 ↑ ↓ ↑ ↑ ↑ ↑ ↨ ↓ ↨ ↨ ↨ 20 ↑ ↑ ↑ ↑ ↨ ↨ ↨ ↨ ↑ 21 ↑ ↑ ↑ ↑ ↨ ↨ ↨ ↨ ↑ ↑ 22 ↑ ↑ ↑ ↑ ↨ ↨ ↑ ↑ ↑ ↑ 23 ↑ ↑ ↨ ↑ ↨ ↨ ↑ ↨ ↨ ↑ ↑ ↓ ↓ ↓ ↓ ↓ ↑ ↑ 24 ↑ ↑ ↑ ↨ ↑ ↨ ↨ ↑ ↑ ↨ ↑ ↓ ↓ ↓ ↓ ↓ ↑ ↑ Our empirical findings are different compared to those studies where only unidirectional relations have been proved (Hussain & Mahmood. Referring back to Table 1.). RTI. GFCE. 2005) and they support those studies where bi-directional relationships have been detected (El-Wassal. most relevant macroeconomic factors (Binswanger. index of capital goods. Tsoukalas.ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009. index of own-account construction work carried out within the country. harmonised consumer price index. MI. 14 domestic product deflator. index of durable consumer goods. Saunders & Tress. Table 1. NEx Granger-cause stock market returns in Lithuania. Vilnius interbank offered rates at different time periods. In such a case. it is worth accepting the predominant relationship. CPIP. 2001. FDI. and rejecting other accidental relations. GDPd. gross external debt Granger-causes OMXV index in different lag lengths except for lag 13 where OMXV index Granger-causes gross external debt according to the empirical testing results. FCE. i. some macroeconomic variables are Granger-caused by OMX Vilnius index (for example. 1991.

According to the empirical findings. Stock returns and the term structure. B. Solothurn University of Applied Sciences. M1. V. Journal of Financial Economics. Binswanger. 61-67. sensitivity of stock returns has decreased drastically during the last decade. Journal of Portfolio Management. Campbell. Agrawalla. (1991). The issue has been widely debated across a variety of markets and time horizons. & Kopecky. Cheung Y. Chen N. International evidence on the stock market and aggregate economic activity. J. S. The Granger causality tests have been applied as the procedure to verify if there is a relationship or statistical causality between stock prices and macroeconomic variables. S. Asprem. consequently. Jagtianti J. Y. 46-63. Some macroeconomic variables such as IDCG. W. M. Bulmash. 13. Time-lagged interactions between stock prices and selected economic variables. T. The analysis embraces 40 different macroeconomic variables and OMX Vilnius stock index reflecting stock price dynamics of Lithuanian companies and. 281-296. Does the stock market predict real activity? Time series evidences from G-7 countries. (1987). M2 have bidirectional causality relations with OMXV index. 13. K. Applied Economics. Discussion paper 2001-04. Conclusions The analysis carried out in this paper reveals that scholars and practitioners do not fully agree whether macroeconomic variables and stock market returns are related and influence each other even though most of the scientists have proved that either macroeconomic variables influence stock market prices or stock market prices influence macroeconomic variables. Besides. Bilson. 1177-1189. A. 22. Journal of Business.. Glosten. Ansotegui. J. & Hayworth. K. M. (1998). & Esteban. S. L. R. W. A. Working paper series available at http://ssrn. (2002). the present paper confirms the existence of relationships between stock market returns and most macroeconomic variables in Lithuania. V. Selecting macroeconomic variables as explanatory factors of emerging stock market returns. (1999). D. C. 12.. W. The controversy of the subject requires a deeper analysis of the issue and the present paper puts some light to the subject by taking into consideration evidences from Lithuania.. A. Journal of Management Research. K. & Ng. Choi. & Hooper. i. R. as some authors point out. Does the stock market still lead real activity? An investigation for the G-7 countries.. 12. Journal of Business Finance and Accounting. 383-403. 7. 8. Economic forces and the stock market. and may stand for a good instrument to testify the present tendencies both for the macroeconomic variables and for stock market returns in Lithuania. 9. S. R.. 5. 10. (2007). 14. 129-142.. 4. Predictable variations in stock index returns. Been. (1999). References 1. Journal of Empirical Finance. C.. Journal of Finance. 2. J. asset portfolios and macroeconomic variables in ten European countries.com/abstract=201908. 23. K. 7. Causality between stock market development and economic growth: a case study of India. Quarterly Journal of Business and Economics. (1990). Allen L. C. (2001).. Roll R. (1997). (1986).. & Jagannathan. Risk and market segmentation in financial intermediaries‘ returns.. Journal of Banking and Finance. J. 5. Stock prices. (1995).e. S. 843-857. 14 may serve as a valuable instrument to predict future tendencies for these macroeconomic factors. Hauser. & Tuteja.. F. M. & Ross S. Abdullah. 17. Cheng. 22. Journal of Financial Service Research. 6.. G. 18. Journal of Banking and Finance. 14 ISSN 1822-6515 ECONOMICS & MANAGEMENT: 2009. 3. J. 1771-1792. bidirectional causality relationships exist between OMXV index and index of durable consumer goods and money supply (M1 & M2).. Brailsford. 34. Macroeconometrics of stock price fluctuations. they are of a coincident nature. 11.. (1989). 889 . 589-612. (1993). 158-168. Cointegration for market forecast in the Spanish stock market. The UK stock market and economic factors: a new approach. 59. L. 32. 373-399. C.ISSN 1822-6515 EKONOMIKA IR VADYBA: 2009. Therefore. The Granger causality tests reveal that some macroeconomic variables may serve as a leading indicator for stock market returns in Lithuania while OMX Vilnius stock market index may serve as a leading indicator for a group of macroeconomic variables. & Trivoli. indicating the overall country’s economical situation. 159-173.

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