Relationship between Macroeconomic Variables and Stock Market Development Evidences from the Indian Economy

Abstract

Stock market performance is considered as the reflector of financial and economic conditions of a country. The dynamic linkage between macroeconomic variables and stock prices has fetched increasing amount of attention from economists, financial analysts, investors and policy makers, since 1980s. There are number of domestic and international macroeconomic factors that potentially can affect the stock returns of the companies (Fama, 1981, Chen et al., 1986). According to Fama (1981), there is a comprehensive group of macroeconomic variables that influences the stock prices in the share market of any country. It is believed that, if a country s economy is performing well and expected to grow at a vigorous pace, the market is frequently anticipated to reflect the same. newlineThe relationship between macroeconomic variables and stock prices has been the focus of an immense body of theoretical and empirical research since the 19th century. The debate over the decades has been whether the movement in stock prices leads to the change in economic activity or it is one of the causes of change. However, the literature suggests some contradictory findings regarding which precise events or economic factors are likely to influence the stock prices and the degree of influencing power of the economic factors. Having generated strong controversy, the debate concerning the relationship between stock market development and macroeconomic variables is still difficult to solve and causality hard to pin down. Arguments both theoretical and empirical have been diverse. Some group of studies advocates that the stock prices do respond to the changes in macroeconomic fundamentals, but the sign and causal relationship might not hold equal for all the studies, given different set for similar macroeconomic variables and also the methodologies used for the study in this area are different (Fama (1981, 1990), Geske and Roll (1983), and Chen, Roll, and Ross (1986)). Further, existing Financial and Economic literature advocates the relationship