Cointegration and Causality between Macroeconomic variables and Stock Prices: Empirical Analysis from Indian Economy

Abstract

The study aims at examining how fiscal fundamental macroeconomic variables affect the performance of the stock market in India by using monthly data from April 2004- July 2015. The study makes use of Ng-Perron unit root tests to check the non-stationarity property of the series; the Auto Regressive Distributed Lag (ARDL) bounds test and a Vector Error Correction Model (VECM) for testing both short and long run dynamic relationships. The variance decomposition (VDC) is used to predict the exogenous shocks of the variables. The findings of the bounds test confirm that there exists a long-run co-integrating relationship between different macroeconomic variables and the stock prices in India. The ARDL result suggests a long-run negative relationship exists between crude oil prices, inflation and stock prices. The results of the influence of both the variables on stock prices are consistent in the short run as well. The results of the short-run estimation confirm positive and significant relationship for Gold, T-bill rates and Real Effective Exchange Rate. The VECM result shows a bidirectional causality is running between Inflation and CNX nifty index. Further, the result indicates the presence of long run causality for the equation with a CNX nifty index as the dependent variable. The results of VDC analysis and IRF show that a major percentage of stock prices change is its own innovative shocks. The study implies that appropriate policy measures should be taken by the proficient authorities for the purpose of controlling inflation, which ultimately leads to the control of volatility of the stock market.