G Aponsu, T Cooray
2017 International Research Journal of Natural and Applied Sciences   unpublished
This study examines whether the performance of Colombo Stock Exchange(CSE), as measured by the All Share Price Index (ASPI), is affected by a set of macroeconomic variables namely, Interest rate, Broad money supply, Index of Industrial Production and Inflation by using quarterly data from 2004:Q1 to 2016:Q3. The Vector Autoregressive (VAR) framework was adopted by initially looking at the long run and short run relationship between stock market and the macroeconomic variables via the Johansen
more » ... integration technique. To further explore the dynamic co-movement among the variables and the adjustment process towards the long run equilibrium, vector error-correction model (VECM) was used. Finally, Impulse Response Function (IRF) and Variance Decomposition (VDC) were employed in order to illustrate the importance of each macroeconomic variable to the stock market movement when a shock is imposed to the system. The analysis reveals that macroeconomic variables and the stock market index are co-integrated and, hence, a long-run equilibrium relationship exists between them. It is observed that the stock prices positively relate to the industrial production but negatively relate to inflationin the long run. The interest rate and money supply are found to be insignificant in determining stock prices in the long run. The results showed that both inflation and money supply significantly and inversely affect stock return in the short run. Furthermore, based on the results of impulse response function and variance decomposition analysis, it is confirmed that that stock market index has stronger dynamic relationship with industrial production index and inflation as compared to money supply and interest rate. Therefore Central Bank of Sri Lanka must undertake pragmatic policies aimed at controlling inflation within acceptable limits, since inflation is seen to inversely affect stock return.