The impact of selected micro and microeconomic variables on the stock prices of emerging stock market: A case of Dhaka Stock Exchange (DSE)

Abstract

History has shown that the price of stocks and other financial assets are an important aspect of the dynamics of economic activity, performing a vital role in national economies. Stock prices can be an indicator of social mood and a leading indicator of the real economic activity. Therefore, economic policy makers keep an eye on the behavior and supervision of stock market, as its smooth and risk free operation is essential for economic and financial stability. Investment in stock market with the intend of generating a positive return without risk is complicated and challenging. Investment in stocks involves risk and uncertainty and capital market helps managing these risk and uncertainty through the construction of efficient portfolio. Therefore, ‘Portfolio Theory’ which was innovated and developed by economists and finance scholars, was a significant breakthrough in financial economics. An effectively diversified portfolio minimizes the unsystematic risk which is affected by factors that are specific to the firms and, to some extent, the industry in which the firm operates. The unsystematic risk is, therefore, manageable by diversification. The systematic risk, however, can not be managed by a simple approach of diversification. In addition to market oriented anomalies, there are many other factors that contribute to the systematic risk of the portfolio. Macroeconomic variables have systematic effects on stock market returns. Asset prices depend on their exposure to the fundamental variables describing the economy. Any systematic variable that affects the economy at the same time affects the returns of a single stock, and consequently the stock market return as a whole. Therefore, market oriented anomalies and systematic macroeconomic variables are vital responsible factors for any rise and fall in stock prices. This research incorporates an interesting attempt to identify those factors that actually influences and causes the volatility in stock prices in Dhaka Stock Exchange (DSE). Few market oriented indicators (i.e. market capitalization, market dividend yield, market earnings per share, market price to earnings multiples and market trading volume) and few macroeconomic indicators (i.e. consumer price index, deposit interest rate, foreign exchange rate, export receipt, foreign exchange reserve, per capita gross domestic product, import payment, investment at current market price, industrial production index, broad money supply, national income deflator, foreign remittances, and total domestic credit) have been incorporated to explain the behavior short run and long run behavior of stock prices in Dhaka Stock Exchange (DSE). In this research, ‘Multivariate Time Series Regression Analysis’ has been applied to identify short run discrete relationship with stock price in Section: A; ‘Johansen’s Cointegration Test’ has been applied to estimate long run equilibrium relationship with stock price; ‘Vector Error Correction Model’ has been applied to estimate short run dynamics (i.e. disequilibrium) adjustment of stock prices that leads to the convergence towards long run equilibrium relationship with other variables and finally, ‘Toda-Yamamoto(T-Y) Granger Causality Test’ has been applied for the identification for long run dynamic causal relationship with stock price in Dhaka Stock Exchange (DSE). The findings of this research has been summarized and presented below: Market capitalization has significant short run and long run positive relationship with stock price. Bi-directional causality is found to exist between market capitalization and stock price. Significant short run positive relationship has been found between market dividend yield and stock price but in the long run, the relationship is positive but significant. Uni-directional causality has been found from market dividend yield and stock price. Market earnings per share have found to have insignificant relationship with stock price both in the short run and long run. In addition, no causal relation is found between them. Market price to earnings multiples has significant negative relationship with stock price in the short run but in the long run, it is negative but insignificant. Uni-directional causality has been found from market price to earnings multiples to stock price. Market trading volume has insignificant positive relationship with stock price but in the long run, it is significant positive. Unidirectional causality has been found from market trading volume to stock price. Consumer price index has insignificant positive relationship with stock price and also had uni-directional causality to stock price. Deposit interest rate has insignificant negative relationship with stock price but in the long run, it is insignificant positive. However, no causality has been found between them. Foreign exchange rate has significant negative relationship with stock price but no causality has been found between them. Relationship between export receipt and stock price is positive but insignificant in the short run but in the long run, it is negative and significant. In addition, bi-directional causal relation exists between them. On the other hand, foreign exchange reserve has insignificant positive relationship with stock price and has unidirectional causality from foreign exchange reserve to stock price. Per capita GDP has significant negative relationship with stock price both in the short run and long run. However, bi-directional causality has been found between them. Import payment has insignificant relationship with stock price in the short run but in the long run, the relationship is positive and significant. Unidirectional causality has been found from import payment and stock price. Aggregate investment has significant negative relationship with stock price in the short run but in the long run, it is positive and significant. In addition, uni-directional causality has been found from aggregate investment and stock price. Industrial production index has insignificant positive relationship with stock price but in the long run, it is significant positive. Bi-directional causality has been found between them. Broad money supply has significant negative relationship with stock price but significant positive relationship has been found in the long run. Uni-directional causality has been found from broad money supply to stock price. National income deflator has significant negative relationship with stock price in the short run but in the long run, the relationship has been turned to be positive and insignificant. Bi-directional causality has been found between them. Foreign remittance has significant negative relationship both in the short run and long run and also has uni-directional causality from foreign remittance to stock price. Finally, total domestic credit has positive but insignificant relationship with stock price in the short run and has no causality with stock price.