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Raman K. Agrawalla
Business Systems and Cybernetics Centre Tata Consultancy Services Limited 6th Floor, Khan Lateef Khan Estate, Fateh Maidan Road Hyderabad – 500 001 Phone: 040 – 5567 1037 Mobile: 91- 9849591947 E-mail:email@example.com firstname.lastname@example.org
Share Prices and Macroeconomic Variables in India: An Approach to Investigate the Relationship Between Stock Markets and Economic Growth
By Raman K Agrawalla
Of late increasing attention is being paid to the relationship between share prices and the macroeconomic variables both by economists and finance specialists. It is in fact hard to imagine an economy without stock markets now. In the contemporary scenario, which can be described by increasing integration of the financial markets and implementation of various stock market reform measures in India, the activities in the stock markets and their relationships with the macro economy have assumed significant importance. The present paper is an attempt to examine for India the causal relationships between the share price index and industrial production in a multivariate vector error correction model which involved certain other crucial macroeconomic variables namely money supply, credit to the private sector, exchange rate, wholesale price index, and money market rate for the reason of right and robust model specification. The purpose is to make a finer point with respect to the relationship between economic growth and stock market especially in terms of stock prices. The present study thus proceeds with a single point investigative agenda- what is the relationship between the health of the real economy and the health of the stock market? Does a rally in share prices reflect better health of the economy or is it the pink economic health that causes share prices to rise? The present study reports causality running from economic growth proxied by industrial production to share price index and not the other way round. It may therefore be stated that the state of the economy has a bearing on the share prices but the health of the stock market in the sense of a rising share price index is not reflective of an improvement in the health of the economy. This finding has lot of implications for the kind of rally we witness in the Indian stock market in the recent years and the Sensex crossing 10000 marks provides a lot of food for thought and research, both theoretical and empirical, in the future.
We see headlines almost daily on the wild gyrations of the Sensex. like many other financial intermediaries. which can be described by increasing integration of the financial markets and implementation of various stock market reform measures in India. The purpose is to make a finer point with respect to the relationship between economic growth and stock market especially in terms of stock prices . It is in fact hard to imagine a world without stock markets now. 1 2. The present paper is arranged as follows: In section 2 we introduce the topic and describes the theoretical framework.e. The stock market. helps transfer funds from surplus spenders (economic agents with excess current income over spending) to deficit spending units (economic agents with current income falling short of spending) and perhaps with higher efficiency. the activities in the stock markets and their relationships with the macro economy have assumed significant importance. NASDAQ.Share Prices and Macroeconomic Variables in India: An Approach to Investigate the Relationship Between Stock Markets and Economic Growth By Raman K Agrawalla 1. the secondary market) deals in outstanding or existing securities. the Dow Jones Industrial Average and the like. Introduction Of late increasing attention is being paid to the relationship between the stock market and the real economy both by economists and finance specialists. the stock market (i. Theoretical framework The stock market is a market where the shares in publicly owned companies (the titles to business firms) are bought and sold. Section 4 discusses the econometric results and Section 5 concludes. In the contemporary scenario. S&P CNX Nifty. the securities 3 . In fact. The present paper is an attempt to examine the interaction between stock prices and a few important macroeconomic variables for India using cointegration analysis. The stock market helps such transmutation of funds to take place through a range of complex financial products called ‘securities’. In section 3 we present a brief review of literature and describe the data sources and the methodology used in the present study.
According to Galbraith (1955). usually to the more efficient ones. It in fact provides individuals with relatively liquid means for risk sharing in investment projects. which provides an image of the underlying or fundamental economic situation. The stock market encourages savings by providing households having investable funds an additional financial instrument. firms need long-term capital and investors usually hesitate to relinquish control over their money for a longer period. This is based on the presumption that foreign investment inflows raises the share prices up and reduces the cost of capital to the corporations of the host country via lowering the price earning ratio. In fundamental valuation sense. It is said that the stock market is a critical cog in the wheel that smoothens the transfer of funds for economic growth. Thus. stock exchanges are expected to accelerate economic growth by increasing liquidity of financial assets. The pricing of shares in the market is critical to how well the stock market performs its allocative role. promoting wiser investment decisions by surplus spending units based on available information. making global risk diversification easier for investors. It lowers the cost of capital for such firms.that have already been issued to surplus spenders by the deficit spending real or financial sector units in the primary or new issues market. For this 1 See Agrawalla. And the stock market brings a compromise between the liquidity needs of both the players providing the facility for trading of stocks. 2005 for an econometric investigation of the relationship between stock market developments in India and its economic growth in the tradition of Levine and other scholars who published their research in the special 4 . It is argued that FII investment though has no real contribution in terms of resource mobilisation. It leads to greater and better allocation of resources in the economy through channelisation of funds to well-managed and profitable firms in comparison to unprofitable and unsuccessful firms. and channeling more savings to corporations. the stock market is but a mirror. yet it could have a crowding in effect on domestic savings and investment mobilisation. For instance. In principle. forcing corporate managers to work harder for shareholders interests. which meets their risk preferences and liquidity needs better. the stock market mobilizes and channels idle resources in the economy to most productive use leading to efficient allocation of savings. a well functioning stock market may help the economic growth and development process in an economy through the following means: • • • Growth of savings Efficient allocation of investment resources Alluring foreign portfolio investment. Broadly speaking. an efficient pricing process rewards well-managed and profitable firms by highly valuing their shares.
1998. It is not a case of choosing those which. 1997. The issue therefore is how well the pricing mechanism works in volume of the World Bank Economic Review. 1996. We have reached the third degree where we denote our intelligence to anticipating what average opinion expects the average opinion to be. 5 . Levine et al.e. relative share prices of companies always reflect their true long-term expected earnings. the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole. who practice the fourth. V A. Keynes (1936) and many of his followers. 1996. perfect competition and no problems of contract enforcement) the price of an asset will reflect its so-called fundamental value and will change only when fundamental economic data change.efficient capital allocation to materialise the market forces must be allowed to work without official interference and market players must be guaranteed all the information they need. A stock market with asymmetric information. strategic factors may have an important impact on trading. so that each competitor has to pick. That is. so that market prices of financial assets may provide biased measures of fundamental values (Aivazian. to take rational market decisions. According to Keynes (1936) this is because speculative and strategic factors dominate the stock market and the following often-quoted statement illustrates his view: “Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs. are really the prettiest. And there are some. fifth and higher degrees” p. Levine. Levine and Zervos. 2000. but those which he thinks likeliest to catch the fancy of the other competitors. all of whom are looking at the problem from the same point of view. when expectations are widely divergent.156 Keynes (1936). without distortion. nor even those which average opinion genuinely thinks the prettiest. According to the efficient pricing process in information arbitrage sense all new information is immediately reflected in share prices. In a perfect market environment (i. Indeed. I believe. to the best of one’s judgement. Relative share prices of firms in an efficient pricing system should reflect their relative expected profitability. not those faces which he himself find the prettiest. in the fundamental valuation of sense. It is suggested in the literature that the sufficient condition requires an efficient takeover mechanism to exist as a market based disciplinary device. It can therefore be argued that efficient prices in the fundamental valuation sense are a necessary condition for stock markets to perform its developmental tasks. in a symmetric information environment with zero transaction costs. however argue that in stock markets prices do not aggregate or communicate information well. is said to be informationally efficient in the sense that prices of securities or financial claims reflect their fundamental value. 1998). but where prices aggregate information fully.
The present study employs a vector error correction model to avoid potential misspecification biases that might result from the use of a more conventional VAR modeling technique (see Naka. industrial production. namely. Causality tests in the present study are preceded by cointegration testing as it is now known that the existence of cointegration has implications for the way in which causality testing is carried out (Granger (1988). credit to the private sector. The data for the macroeconomic variables were extracted from the IFS database (International Financial Statistics (IFS) CDROM). The first step in the analysis is to subject the macroeconomic series to unit root tests or tests the series for stationarity. Finally the causality tests among the cointegrated variables are undertaken. In the empirical analysis. the variables are used in their logarithm. Sims et al.e. share price index. Mukherjee and Tufte. we deseasonalise all the data series by the X-11 method. the next step is the testing for cointegration. 6 . The stock market is thus in the focus of the economists and policy makers because of the perceived benefits it provides for the economy. The additional advantage of carrying out cointegration testing is that it provides evidence on the existence of a stable long-run equilibrium relationship between the macro economic variables and stock prices. Research Methodology and Sources of Data The empirical analysis in the present study is based on multivariate Granger-Causality tests within an error correction framework . An active stock market may be relied upon to measure changes in general economic activities using the stock price index. 2 Sources of Data The present study uses relatively longer time series of monthly data for the period 1965:11 (November 1965) to 2000:10 (October 2000) for India on the following macroeconomic variables. This helps check whether the series are co-integrated i. 3. which is interesting from a theoretical perspective. wholesale price index. (1990). Since the study uses the monthly data. 2 The detail exposition of the methodology is not presented here to save space. money supply. 2001). whether there is any long-run relationship among the variables chosen. exchange rate. The stock market provides the fulcrum for capital market activities and it is often cited as a barometer of business direction. The present study uses Johansen Cointegration Tests for the purpose. and money market rate. Toda and Phillips (1993)). After testing the series for stationarity.practice and how successfully the various stock market functions are performed in practice in the real world.
Growth in industrial production responds negatively to a real stock return shock. It is through this mechanism that macroeconomic variables become part of risk factors in equity markets. The more recent examples in this respect are found in Cheung and Ng (1998) and Gjerde and Saettem (1999). the performance of the foreign stock market (difference between the continuously compounded return on S & P 500 index and the USA inflation rate) and domestic real stock returns (difference between the continuously compounded return on the Athens general stock market index and Greek inflation rate). economic forces affect the discount rates. Review of Literature There are various ways in which the stock market and the macro economy have been related in the literature. In this approach. viz. In fact. the ability of firms to generate cash flows and future dividend payments. The major finding of the study is that the domestic market economic activity affects the performance of domestic stock market. The following variables are taken as the indicator of economic activity. 7 . 4 For examples or references of such studies based on country like the USA. industrial production as a measure of output. A particularly popular model in this area is the vector autoregression (VAR) model. the UK. It uses the monthly data for the period 1984:1 to 1999:9 for Greece. real oil prices (Consumer price index (CPI) for fuels deflated by CPI). interest rate. Roll and Ross (1986) economic variables have a systematic effect on stock market returns. 2004). Singapore. exchange rate. More recently. That is. Lee (1992) is a pioneering application of the VAR model to the relationship between share prices and the macro economy.. Hondroyiannis and Papapetrou (2001) investigate whether movements in the indicators of economic activity affect the performance of the stock market for Greece. implying that an increase in real stock returns does not necessarily lead to a higher level of industrial production. One important approach in this regard has been from the asset-pricing perspective.. a greater part of research in this line has been mostly for developed countries . According to Chen. see Groenewold (2004). The 3 4 3 The APT essentially seeks to measure the risk premia attached to various risk factors and attempts to assess whether they are significant and if they are priced into stock market returns. Australia etc. Impulse response analysis carried out in the study shows that all the macroeconomic variables are important in explaining stock price movements. The study performs a VAR analysis to analyse the dynamic interactions among indicators of economic activity.4. the framework used for the analysis was the Arbitrage Pricing Theory (APT) to address the question of whether risk associated with particular macroeconomic variable is reflected in expected asset returns. empirical models without any specific theoretical structure have been applied in a more pragmatic fashion to the two-way relationship between share prices and macroeconomic variables (Groenewold.
After accounting for macroeconomic factors the Indian stock markets still appear to be drawn downward by residual negative trend.empirical results suggest that the Greek stock market returns do not rationally signal changes in the overall macroeconomic activity. The results reported in the study indicate that stock prices lead nominal income. and are relatively insensitive to factors internal to the financial system such as market mechanisms. and domestic output growth as its predominant driving force. The results of the study suggest that domestic inflation is the most severe deterrent to Indian stock market performance. But this study runs causality tests in an error correction framework on non-cointegrated 8 . price level (Consumer Price Index). Mukherjee and Tufte (2001). One is long-run monetary neutrality. nominal income (Gross National Product). Pethe and Karnik (2000). the price level and the exchange rate. The signs on these relations are consistent with macroeconomic theory. Naka. a narrow measure of money supply. The study uses data for the period 1960:1 to 1995:4 for India on the following macroeconomic variables. The study includes five macroeconomic variables namely broad divisia money supply aggregate. It employs the methodology of Granger noncausality proposed by Toda and Yamamoto (1995) for the sample period 1981:1 to 1994:4 to test whether the Malaysia stock market can act as a barometer for the Malaysian economy. Real stock returns respond negatively to interest rate shocks. but money supply and interest rate lead the stock price. Shah and Thomas (1997) argue that because of the enabling government policies stock market in India is more efficient than the Indian banking system both in terms of quality of information processing and imposition of transaction cost. using Indian data for April 1992 to December 1997. while a depreciation of the currency leads to higher real stock market returns. the second relates interest rates to output (i. It employs a vector error correction model to avoid potential misspecification biases that might result from the use of a more conventional VAR modeling technique. and the money market rate in the Bombay inter bank market. namely. and the third relates nominal stock prices to nominal GDP and a downward trend. the Industrial production index. the consumer price index. The study used Gandolfo’s (1981) technique to interpolate quarterly data series from annual observations of GNP. analyses long-term equilibrium relationship among selected macroeconomic variables and the Bombay Stock Exchange index. attempts to find the way in which stock price indices are affected by and affect other crucial macroeconomic variables in India.. Their research support the idea that stock prices are a mirror which reflect the real economy.e. interest rate (3-month Treasury bill rate) and the exchange rate (Real Effective Exchange Rate). Habibullah et al (2000) determines the lead and lag relationships between Malaysian stock market and five key macroeconomic variables. The study finds that the five variables are cointegrated and there exists three long-term equilibrium relationships among these variables. an IS function). However the arguments require more explanation.
In the empirical analysis firstly. both without and with trends.variables. However. which are available with the author. we test for the order of integration of the macroeconomic variables. For this purpose. Discussion of Results Descriptive Statistics and Correlation Matrix Table 1 and Table 2 report descriptive statistics and the correlation matrix involving the variables under study. The study of course avers that in the absence of cointegration it is not legitimate to test for causality between a pair of variables and it does so in view of the importance attached to the relation between the state of economy and stock markets. which is inappropriate and not econometrically sound and correct. to derive robust and meaningful results we proceed. to test the time series properties of the macroeconomic series. The study reports weak causality running from IIP to share price index (Sensex and Nifty) but not the other way round. The positive trend in the data set can be seen from Chart 1 and Charts 2 to 5 depicts the share price index and returns on it. 9 . it holds the view that the state of economy affects stock prices 5. 5 5 The charts 1 to 5. the variables are subjected to unit root tests of Augmented Dickey and Fuller (ADF) and Phillips and Perron (PP). Table 2 reports very high positive correlation among different pairs of macroeconomic variables. The unit root results are presented in Table 3(a) and Table 3(b). though the mean of the share price index is less than the mean of the industrial production. As expected the share price index is more volatile than the industrial production. In other words. are not produced here to save space. as described in the methodology chapter. Further.
734016 399 LWPI 3.931137 1.941074 0.639298 1.648506 2.985616 0. LEXR = Log of exchange rate. Unit root tests results As evident from the unit root results presented in Table 3(a). credit to the private sector. Dev. LWPI = Log of wholesale price index. LCP = Log of credit to the private sector.438453 3.157404 0. and wholesale price index 10 .000000 Note: LSPI = Log of share price index.000000 LMS 0.926914 0.202639 399 LCP 5.771923 -0.914506 1.241279 4.982117 0.000000 LWPI 0.905571 2.233173 1.818726 399 LMS 6.Table 1: Descriptive Statistics LSPI Mean Median Maximum Minimum Std.953401 1.563370 4.972598 0.922234 1.312449 1. industrial production.545282 -0. only Money market rate variable is stationary in level but the other macroeconomic variables namely share price index.955014 0.553454 0.987457 1. LCP = Log of credit to the private sector.236236 3. LEXR = Log of exchange rate. LMS = Log of money supply.790499 399 Note: LSPI = Log of share price index.938442 0.755517 1.000000 LIP 0. LIP = Log of industrial production.649428 -0.876549 399 LIP 3.114826 6.996705 0.812938 3. money supply.560647 0.999459 0.521891 3.910231 3.770409 2. exchange rate.000000 LCP 0.929725 8. LIP = Log of industrial production.747427 399 LEXR 2.256871 1. LWPI = Log of wholesale price index.947028 0.777399 2.000000 LEXR 0.876013 5.077710 1.594516 0.146732 8. LMS = Log of money supply.021132 1.195777 0.995875 1.529222 2. Skewness Kurtosis Observations 2.931989 0.383373 1.007460 1. Table 2: Correlation Matrix LSPI LSPI LIP LMS LEXR LCP LWPI 1.700084 4.
So for the testing of cointegration among the variables.88 and -2.313*** 11 .074 -1. LEXR and LWPI are 3. exchange rate. 10 and 20 respectively on the basis of the Akaike Information Criterion (AIC). LCP.722 -4.14 (with trend) respectively for both the Augmented Dickey Fuller (ADF) and Phillips Perron (PP) tests.are nonstationary in level.02. -3. ** and * indicate statistical significance at 1 per cent. LIP = Log of industrial production.401 0. on the basis of both the ADF and the PP tests.454*** ADF -0. 14.025*** -2. ***. while the MMR is I(0). the MMR is dropped from the further analysis.235 -2. MMR = Money market rate 2. industrial production. LIP. 5% and 10% significance levels are-3.118 -0.100 -0. LWPI = Log of wholesale price index.625 -1. However. money supply. 3. 5 per cent and 10 per cent respectively Constant and Trend ADF -1.57 (without trend) and -4.340 -1. LMS. 16. and wholesale price index are stationary on first differencing at 1 per cent level of significance. Table 3(a): Unit Root Tests On Levels Constant & No Trend Variable LSPI LIP LMS LCP LEXR LWPI MMR Note: 1.856*** PP -1. The optimal lag selected for LSPI. all the variables namely share price index.707 -0. 12. -2. Thus. LCP = Log of credit to the private sector.922 -11.203 -3. LMS = Log of money supply.885*** PP -0. except the Money market rate (MMR) are I(1). The critical values for unit root tests at 1%. 4.726 -0.838 -9. it is concluded that all the variables considered here.795 -1. as shown in Table 3(b).594 -2.821 -2.162 -0. credit to the private sector. LEXR = Log of exchange rate.47.716 -8.261 -0.404 -1.058 -1.44 and -3.097 0.232 -1. LSPI = Log of share price index.
47. Table 4: Johansen Cointegration Test Eigenvalue 0.991*** PP -14. LIP = Log of industrial production.15 1 Percent Critical Value 103. LCP.192*** -4. LSPI = Log of share price index.049*** Cointegration tests results Table 4 presents the results of the Johansen Cointegration tests.57 (without trend) and -4.10926 5 Percent Critical Value 94. 3. ** and * indicate statistical significance at 1 per cent.582*** -18.156*** -4. 14.224*** -48.18 Hypothesized No. 10 and 20 respectively on the basis of the Akaike Information Criterion (AIC). of CE(s) None * 12 .205*** -6. LCP = Log of credit to the private sector. LEXR = Log of exchange rate.02.973*** -13.862*** -34. LMS = Log of money supply.984*** -13. ***.032*** ADF -10.14 (with trend) respectively for both the Augmented Dickey Fuller (ADF) and Phillips Perron (PP) tests.902*** -6.742*** -33. 12. LEXR and LWPI are 3. MMR = Money market rate 2.805*** -35. -2.085131 Likelihood Ratio 99. 5 per cent and 10 per cent respectively Constant and Trend ADF -10.060*** -4.88 and -2.Table 3(b): Unit Root Tests On First Differences Constant & No Trend Variable LSPI LIP LMS LCP LEXR LWPI Note: 1. The optimal lag selected for LSPI. -3.374*** -7. The critical values for unit root tests at 1%.381*** -4.261*** -5. LWPI = Log of wholesale price index. 4. 5% and 10% significance levels are-3. 16.354*** -33. LMS.44 and -3. LIP.010*** PP -14.190*** -4.412*** -4.214*** -48.131*** -18.
22952 7.45585 41.0.000 Constant -14. 6 The first row in the Table 4 tests the hypothesis of no cointegration. there is a long run equilibrium relationship between the share price index and the select macroeconomic variables. the third row tests the hypothesis of two cointegrating relations.039550 0.68 15.04 6. the share price index and the macroeconomic variables are cointegrated.65 At most 1 At most 2 At most 3 At most 4 At most 5 * denotes rejection of the hypothesis at 5% significance level.469] 6 Causality tests results The result of the estimated multivariate VECM (vector error correction model) is presented in Table 5.46 35. Note that in this model we allow for a non-zero intercept in the cointegration relationship and a linear trend in the data. all against the alternative hypothesis of full rank.e. 13 . the second row tests the hypothesis of one cointegrating relation. That is. the variables share price index.226 LIP 6.52 47. i.001059 66.65 20.239 LMS -3.065663 0. As already indicated.07 54. The estimated cointegrating vector.76 76. exchange rate and the wholesale price index only. all series in the VAR are stationary. Note: Likelihood Ratio test indicates one cointegrating equation at 5 % significance level.41 3. while the industrial production. That is.018976 0. and the optimal lag length is selected to be 9 for the vector error correction model.53008 22. The Johansen test indicates that there is one cointegrating equation at 5 % significance level. exchange rate and the wholesale price index adjust to disequilibrium from the long-run relationship. The results in Table 5 clearly show significant error correction terms for the variables namely share price index.286 LEXR -4.161 LCP -3. money supply and credit to the private sector do not significantly respond to deviations from the long-run relationship.388773 68. and so on. normalised on the LSPI is: LSPI [1.051231 0. The critical values for the trace statistic reported are from Osterwald-Lenum (1992).144 LWPI 10.419873 0.21 29.
In other words.469) ∆LWPI -0. We here present the causality findings involving only the SPI and IP as the dependent variable because the objective of the present study is to test the causality relationship between stock market and economic growth where the latter is proxied by industrial production only.002 (-0.Table 5: Vector Error Correction Estimation Independent Variable ∆LSPI Constant 0.355) ∆LEXR 0.0006 (-0.001 (-0.026 (4.292) -0. LEXR = Log of exchange rate. ∆ is the change operator.0032 (1. LCP = Log of credit to the private sector.013 (-2.010 (0.0039 (2. causality runs from economic growth (proxied by industrial production) to stock price index both through past changes in economic growth and past levels of economic growth. at the conventional level of significance.0034 (-3. 2. LSPI = Log of share price index.735) ECt-1 term -0.192) ∆LCP 0. LWPI = Log of wholesale price index. t-statistics are reported in the parenthesis. but also the error correction term is significant at the 5 per cent significance level (see the p-value of the ECM term in equation 1 which is 0.881) -0.024 (5. As seen from the results.003 in the Table 6. In contrast. the findings in equation 2 of Table 6 indicate absence of causality from stock prices to economic growth. Dependent Variable ∆LIP 0.427) 0.005 (1. not only the lag values of industrial production are significant (see that the p-value is 0. LMS = Log of money supply.204) ∆LMS 0.014 (1.164) 0.010). 3. LIP = Log of industrial production. 14 .069) Table 6 presents the results of causality tests in a cointegration framework for the multivariate model.639) Note: 1. there is evidence of causality from economic growth to stock price index. Because in the equation 1 in Table 6 which involves share price index as the dependent variable.064) -0. in the bold font).
392 ∆LWPI F-stat =3. while the coefficient on the error correction (EC) term in the error correction model reflects long run Granger causality relationships (Jones and Joulfaian.003 Eq..010 F-stat = 3. 1991 and Perman. *** indicate statistical significance at 1 per cent level of significance.193 pppvalue=0. 7 15 . Dep.586 p-value=0. 022 ∆LSPI F-stat =1.842 Coefficients of Independent Variables ∆LMS F-stat = 1. running from share price index to industrial production which implies that the revival of stock market. Variable Coefficient of ECMt—1 ∆LIP 1.276 value=0. in a more candid manner . No. Variable ∆IP Coefficient of ECMt—1 t-stat= -0.19 (0. It shows that causality runs from economic growth (proxied by industrial production) to share price index implying that the state of the economy affects share prices in India. P-values are in the parentheses.58 (0. Our finding categorically rejects the null hypothesis “economic growth does not cause share prices” as evident from the table 7.84) economic growth Notes: 1. No.031 ∆LEXR F-stat = 0. 298 Coefficients of Independent Variables ∆LMS F-stat = 2.39) -0. Dep.01)*** cause share prices Share prices does not cause 1. 7 Table 7: Causality test between economic growth and share prices Null Hypothesis F-Statistics with P-value for Short-run Noncausality t-Statistics with P-value for Long-run Noncausality Economic growth does not 3.069 pvalue=0.647 pvalue=0. In other words.433 F-stat = 1.0008 2.007 p-value=0.198 p-value=0. either in the short run or in the long run.059 pvalue=0. Now we present the Causality test result between economic growth and share prices in Table 7. That is. 2.267 p-value=0. but not the other way round.51 (0.184 pvalue=0. in the sense of rising share prices could not be taken to be a leading indicator of the revival of the economy in India.06 (0.435 ∆LCP ∆LWPI F-stat =1.171 value=0.755 ∆LCP F-stat = 2.003)*** -0.227 ∆LEXR F-stat = 1.508 pvalue=0. ∆LSPI t-stat= .Table 6: Causality Tests in the VECM Eq. 1991). there is no evidence of causality. the stock price index The basis of such presentation is the arguments that the lagged coefficients on the independent variables in the error correction model represent short run Granger causality.
cannot be considered as a barometer of business direction or it cannot be relied upon to measure changes in the general economic activities in India. Pethe and Karnik (2000) report similar results. The present study reports causality running from economic growth proxied by industrial production to share price index and not the other way round. and money market rate for the reason of right and robust model specification. a Bull Run or rising prices in the stock market cannot be taken to be a leading indicator of the revival of the economy in India. Our results are also consistent with Hondroyiannis and Papapetrou (2001). exchange rate. “Stock Market and the Real Economy: A policy perspective for India from Time Series Econometric Analysis” presented at the 42nd Annual Conference of the Indian Econometric Society (TIES) held at the Guru Nanak Dev University. References Agrawalla. in the future. The present study thus proceeds with a single point investigative agendawhat is the relationship between the health of the real economy and the health of the stock market? Does a rally in share prices reflect better health of the economy or it is the pink economic health that causes share prices to rise? We examined the causal relationships between the share price index and industrial production in a multivariate vector error correction model which involved certain other crucial macroeconomic variables namely money supply. 2005. The purpose is to make a finer point with respect to the relationship between economic growth and stock market especially in terms of stock prices. Raman K. 2006 16 . which indicate that the domestic economic activity affects the performance of domestic stock market in Greece. credit to the private sector. the state of the economy has a bearing on the share prices but the health of the stock market in the sense of a rising share price index is not reflective of an improvement in the health of the economy. Amritsar on 5-7 January. That is. This finding has lot of implications for the kind of rally we witness in the Indian stock market in the recent years and the Sensex crossing 10000 marks provides a lot of food for thought and analysis. wholesale price index. which find evidence in support of the fact that the Malaysia stock market acts as a barometer for the Malaysian economy. However. Concluding Comments To sum up. the present study attempts to investigate whether share price index can be considered as a mirror or reflection of economic activities in India. our findings contradict Habibullah et al (2000). 5. In other words. both theoretical and empirical. It may therefore be stated that the stock markets in India are demand driven and industry led which means that demand for greater equity finance is led by higher and improved industrial performance.
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