Relationship between Stock Market Index and Macroeconomic Indices: Empirical Evidence from Bangladesh

Abstract

Stock market is often believed to be a predictor of the economy in which it operates. We try to find empirical evidence defining the relationship between stock market index and macroeconomic indices of Bangladesh. Specifically, we investigate to see if there exists any relationship between Dhaka Stock Exchange General Index (DSEGEN) and some important macroeconomic variables which represent the economy of Bangladesh. Based on the objectives, following six specific research questions are investigated: (1) Does any significant long-run association exist between DSEGEN and six macroeconomic variables viz.; industrial production index, interest rate, inflation, exchange rate, money supply and gold price? (2) Is there any short-term relationship between DSEGEN and the macroeconomic variables? (3) Is there any causal relationship between DSEGEN and the macroeconomic variables? (4) Are the relationships same between DSEGEN and the macroeconomic variables in bubble, meltdown and recovery periods of the stock market? (5) Does any relationship exist between DSEGEN volatility and the macroeconomic volatility? (6) What is the relationship between DSEGEN and the real economy of Bangladesh? This study has used the macroeconomic version of the semi strong EMH and macro variable model of the APT to investigate the aforesaid research questions using sophisticated econometric tools - such as Vector Autoregression, Granger Causality, Johansen and Juselius Cointegration, Autoregressive Distributed Lag (ARDL), and Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model. The investigations on 25 years data, from January 1991 to December 2015, have revealed that there exists a long-run equilibrium relationship and a short-run disequilibrium between the stock market and the macroeconomic variables in Bangladesh. Also, the stock market has Granger caused only two macroeconomic variables - industrial production and exchange rate, but the opposite is not true. Among the catastrophes of 1996 and 2010, structural instability is found around 1996. The findings have also indicated that the exchange rate and the interest rate are at least partially responsible for the bubble creation and bubble crash of 1996. The explanatory power of the macroeconomic variables to explain the stock market return varies across bubble, meltdown and recovery periods of 1996 indicating that the stock prices are sometimes partially driven by fad and fashions, which are not related to the economic factors. Furthermore, no leverage effect is seen in the stock market volatility, although a shock has persisted over many future periods. The market volatility has showed instability throughout the period revealing that the volatility of the market is a problem in Bangladesh. Moreover, the outcome of the study has also revealed that despite numerous reform measures and the automation initiatives being implemented since 1998, stock market in Bangladesh is not yet that much developed to play its due role in influencing the real economy.