Dynamic Relationship between Macroeconomic Variables and Stock Returns: Empirical Evidence in Case of Sri Lanka.

Abstract

Linkages between macroeconomic variables (MV) and stock return are still obscure in developing counties as mixed results were observed by various researchers in different time intervals. Therefore, the objectives of the study are (i) to identify the relationship between MV (exchange rate, interest rate, inflation rate, money supply) and all share total returns (ASTRI) of listed companies in Colombo Stock Exchange (CSE) in Sri Lanka during 2010 to 2017 and (ii) to examine whether long run or short run causality running from MV to ASTRI of listed companies in CSE. Period of research data covers from 2010 to 2017. ASTRI of this period was collected from Data Library of CSE. Inflation rate, three-month primary market Treasury bill yield rate, Broad money supply (M2) and Exchange rate were collected from website of Central Bank of Sri Lanka. Descriptive, ADF test for unit root, Johnson co-integration test and VECM are used to analyse the collected data. Results show that ADF variables are stationary I(1). Johansen tests for cointegration reveals that there is one co-integration between MV and ASTRI. It is also noted that there is no significance short run causality from MV to ASTRI. However, it observed that out of four MV, exchange rate is notable negative impact on ASTRI in short run. It is concluded that in the long run, Interest rate and Money Supply have a positive impact on ASTRI whereas Exchange rate and Inflation rate have a negative impact on ASTRI. Findings of the study help to existing and prospective investors, mangers of the company and policy makers how MV to be considered to make decision as those variables impact on the stock return.