Causal Relationship between Macro-Economic Indicators and Stock Market in India

Abstract

This paper investigated the market efficiency and causal relationship between selected Macroeconomic variables and the Indian stock market during the period January 2005 to February 2011 by using Ljung-Box Q test, Breusch-Godfrey LM test, Unit Root test, Granger Causality test.The study confirms the presence of autocorrelation in the Indian stock market and macro economic variables which implies that the market fell into form of Efficient Market Hypothesis. Further the Granger-causality test shows evidence of bidirectional relationship between interest rate and stock market, exchange rate and stock market, international stock market and BSE volume, exchange rate and BSE volume. So it suggests that any change of  exchange rate, interest rate and international market significantly influencing the stock market in the economy and vice versa. The study also reported unidirectional causality running from international stock market to domestic stock market, interest rate, exchange rate and inflation rate indicating sizeable influence in the stock market movement in the considered period. The study points out that the Indian stock market is sensitive towards changing behavior of international market, exchange rate and interest rate in the economy and they can be used to predict stock market price fluctuations.