Macroeconomic Variables and Stock Market Development in India: An Application of ARDL Bounds Testing Approach

Abstract

This paper examines the relationship between selected macroeconomic variables and stock market development in India using quarterly data from 1996:Q1 to 2012:Q3. Ng-Perron unit root test is utilized to check the order of integration of the variables. The long-run relationship is examined by implementing the ARDL bounds testing approach. VECM method is used to test the short and long-run causality, and variance decomposition is used to predict long-run exogenous shocks of the variables. Results confirm a long-run relationship among the variables. Evidence suggests that economic growth, FIIs and Trade openness in India influence the stock market capitalization positively. The VECM result indicates short-run unidirectional causality running from trade openness to stock market development. Result of variance decomposition shows that stock market development is mostly explained by trade openness. The Government can take steps to encourage FDI and trade openness to facilitate investment in stock markets, which will lead to increased economic activity