Journal of Asset Management

, Volume 13, Issue 2, pp 115–127

Do macro-economic variables explain stock-market returns? Evidence using a semi-parametric approach

  • Sagarika Mishra
  • Harminder Singh
Original Article

Abstract

In this article we test whether the stock market in India is driven by macro-economic fundamentals. We use a non-parametric approach to determine whether any variables are nonlinearly related with stock returns and the variability of stock returns by taking monthly observations from 1998 to 2008. We consider exchange rate, interest rate, industrial production, inflation and foreign institutional investments as macro-economic factors. Further, we employ a semi-parametric approach to see whether any of the macro-variables have a significant nonlinear impact on the stock return and on the variability of stock return. Our results suggest that of the Ordinary Least Square and semi-parametric approaches, the semi-parametric approach better explains the stock returns and volatility.

Keywords

semi-parametric model Indian stock return macro-economic variables 

References

  1. Ananthanarayanan, S., Krishnamurti, C. and Sen, N. (2005) Foreign institutional investors and security returns: Evidence from Indian stock exchanges. Paper presented at the CAF Hosts Annual Winter Research Conference in France.Google Scholar
  2. Apergis, N. and Eleftheriou, S. (2002) Interest rates, inflation, and stock prices: The case of the Athens Stock Exchange. Journal of Policy Modelling 24: 231–236.CrossRefGoogle Scholar
  3. Asprem, M. (1989) Stock prices, asset portfolios and macroeconomic variables in ten European countries. Journal of Banking and Finance 13: 589–612.CrossRefGoogle Scholar
  4. Babu, M.S. and Prabheesh, K.P. (2008) Causal relationship between foreign institutional investments and stock returns in India. International Journal of Trade and Global Markets 1 (3): 259–265.CrossRefGoogle Scholar
  5. Bailey, W. and Chung, Y.P. (1996) Exchange rate fluctuations, political risk and stock returns: Some evidence from an emerging market. Journal of Financial and Quantitative Analysis 30: 541–562.CrossRefGoogle Scholar
  6. Bartov, E. and Bodnar, G.M. (1994) Firm valuation, earnings expectations, and the exchange rate exposure effect. The Journal of Finance 49: 1755–1785.CrossRefGoogle Scholar
  7. Bhaduri, S.N. (2005) Investment, financial constraints and financial liberalisation: Some stylised facts from a developing economy, India. Journal of Asian Economics 16: 704–718.CrossRefGoogle Scholar
  8. Bilson, C.M., Brailsford, T.J. and Hooper, V.J. (2001) Selecting macroeconomic variables as explanatory factors of emerging stock market returns. Pacific-Basin Finance Journal 9: 401–426.CrossRefGoogle Scholar
  9. Bradley, M.D. and Jansen, D.W. (2004) Forecasting with a nonlinear dynamic model of stock returns and industrial production. International Journal of Forecasting 20: 321–342.CrossRefGoogle Scholar
  10. Bredin, D. and Hyde, S. (2008) Regime changes and the role of international markets on the stock returns of small open economies. European Financial Management 14 (2): 315–346.CrossRefGoogle Scholar
  11. Canova, F. and De Nicolo, G. (2000) Stock returns, term structure, inflation and real activity: An international perspective. Macroeconomic Dynamics 4: 343–372.CrossRefGoogle Scholar
  12. Chan, L.K.C., Karceski, J. and Lakonishok, J. (1998) The risk and return from factors. Journal of Financial and Quantitative Analysis 33 (2): 159–189.CrossRefGoogle Scholar
  13. Chen, N.F., Roll, R. and Ross, S.A. (1986) Economic forces and the stock market. The Journal of Business 59 (3): 383–403.CrossRefGoogle Scholar
  14. Chue, T.K. and Cook, D. (2008) Emerging market exchange rate exposure. Journal of Banking and Finance 32: 1349–1362.CrossRefGoogle Scholar
  15. Clark, J. and Berko, E. (1997) Foreign Investment Fluctuations and Emerging Market Stock Returns: The Case of Mexico. Federal Reserve Bank of New York, Working Paper 9635.Google Scholar
  16. Cutler, D.M., Poterba, J.M. and Summers, L.H. (1989) What moves stock prices? Journal of Portfolio Management 15: 4–12.CrossRefGoogle Scholar
  17. Day, T.E. (1984) Real stock returns and inflation. Journal of Finance 39: 493–502.CrossRefGoogle Scholar
  18. De Santis, G. and Gerard, B. (1998) How big is the premium for currency risk? Journal of Financial Economics 49: 375–412.CrossRefGoogle Scholar
  19. Dhrymes, P.J., Friend, I. and Gultekin, N.B. (1984) A critical re-examination of the empirical evidence on the arbitrage pricing theory. The Journal of Finance 39: 323–346.CrossRefGoogle Scholar
  20. Dumas, B. and Solnik, B. (1995) The world price of foreign exchange risk. Journal of Finance 50: 445–479.CrossRefGoogle Scholar
  21. Fama, E.F. (1990) Stock returns, expected returns and real activity. Journal of Finance 45: 1089–1108.CrossRefGoogle Scholar
  22. Fama, E.F. and Schwert, G.W. (1977) Asset returns and inflation. Journal of Financial Economics 5: 115–146.CrossRefGoogle Scholar
  23. Feldstein, M. and Summers, L. (1979) Inflation and the taxation of capital income in the corporate sector. National Tax Journal 32: 445–470.Google Scholar
  24. Gordon, J. and Gupta, P. (2003) Portfolio Flows into India: Do Domestic Fundamentals Matter? IMF Working Paper.Google Scholar
  25. Goswami, G. and Jung, S.C. (1997) Stock Market and Economic Forces: Evidence from Korea. Working Paper.Google Scholar
  26. Griffin, J. and Stultz, R. (2001) International competition and exchange rate shocks: A cross-country industry analysis of stock returns. Review of Financial Studies 14: 215–241.CrossRefGoogle Scholar
  27. Gupta, M. and Finnerty, J.E. (1992) The currency risk factor in international equity pricing. Review of Quantitative Finance and Accounting 2 (3): 245–257.CrossRefGoogle Scholar
  28. Hastie, T. and Tibshirani, R. (1990) Generalized Additive Models. Boca Raton, FL: Chapman & Hall CRC.Google Scholar
  29. James, C., Koreisha, S. and Partch, M. (1985) A VARMA analysis of the causal relations among stock returns, real output, and nominal interest rates. Journal of Finance 40 (5): 1375–1384.CrossRefGoogle Scholar
  30. Jorion, P. (1990) The exchange rate exposure of US multinationals. Journal of Business 63 (3): 331–345.CrossRefGoogle Scholar
  31. Korajczyk, R.A. and Viallet, C.J. (1989) An empirical investigation of the international asset pricing. Review of Financial Studies 2: 553–585.CrossRefGoogle Scholar
  32. Li, Q. and Racine, J. (2007) Nonparametric Econometrics: Theory and Practice. USA: Princeton University of Chicago Press.Google Scholar
  33. Loudon, G.F. (1993) Foreign exchange exposure and the pricing of currency risk in equity returns: Some Australian evidence. Pacific-Basin Finance Journal 1 (4): 335–354.CrossRefGoogle Scholar
  34. Malkiel, B. (1979) The capital formation problem in the US. Journal of Finance 34: 291–306.CrossRefGoogle Scholar
  35. Merton, R.C. (1987) A simple model of capital market equilibrium with incomplete information. Journal of Finance 42: 483–510.CrossRefGoogle Scholar
  36. Nissim, D. and Penman, S.H. (2003) The association between changes in interest rates, earnings, and equity values. Contemporary Accounting Research 20 (4): 775–804.CrossRefGoogle Scholar
  37. Patnaik, I. and Shah, A. (2004) Interest Rate Volatility and Risk in Indian Banking. IMF Working Paper, WP/04/17.Google Scholar
  38. Roll, R. (1992) Industrial structure and the comparative behaviour of international stock indexes. Journal of Finance 47: 3–41.CrossRefGoogle Scholar
  39. Roll, R. and Ross, S.A. (1980) An empirical investigation of the arbitrage pricing theory. Journal of Finance 35: 1073–1103.CrossRefGoogle Scholar
  40. Ross, S.A. (1976) The arbitrage theory of capital asset pricing. Journal of Economic Theory 13: 341–360.CrossRefGoogle Scholar
  41. Rozeff, M. (1974) Money and stock prices: Market efficiency and the lag in the effect of monetary policy. Journal of Financial Economics 34: 245–302.CrossRefGoogle Scholar
  42. Schwert, G.W. (1990) Stock returns and real activity: A century of evidence. Journal of Finance 45: 1237–1257.CrossRefGoogle Scholar
  43. Schwert, P. (1981) The adjustment of stock prices to information about inflation. Journal of Finance 36: 15–29.CrossRefGoogle Scholar
  44. Shiller, R.J. (1988) Causes of changing financial market volatility. In financial market volatility. The Federal Reserve Bank of Kansas City: 1–22.Google Scholar
  45. Sytse, D., George, R. and Rezaul, K. (2003) Foreign and domestic ownership, business groups and firm performance: Evidence from a large emerging market. Strategic Management Journal 27: 637–657.Google Scholar
  46. Trzcinka, C. (1986) On the number of factors in the arbitrage pricing model. Journal of Finance 41: 347–368.CrossRefGoogle Scholar
  47. Warther, V. (1995) Aggregate mutual fund flows and security returns. Journal of Financial Economics 39: 209–235.CrossRefGoogle Scholar

Copyright information

© Palgrave Macmillan, a division of Macmillan Publishers Ltd 2011

Authors and Affiliations

  • Sagarika Mishra
  • Harminder Singh
    • 1
  1. 1.School of Accounting, Economics & Finance, Deakin UniversityBurwoodAustralia

Personalised recommendations