Dynamic Relationship among the Stock Market and the Macroeconomic Factors

Abstract

This article examines the dynamic relationship among the stock market and macroeconomic factors for the stock market of Nepal. The study documented both short-run and long-run interdependence among stock index and some macroeconomic variables. The estimated results suggest unidirectional short-run (positive) causal relationship running from consumer price index (CPI) to stock index but reverse causality in the long run (from stock index to CPI), supporting the widely-held view that stock returns are a hedge against inflation. The multivariate results also confirmed absence of long-run causality but supported positive and unidirectional relationship flowing from money supply to stock index in the short run. Nevertheless, the multivariate results revealed longrun causality running from stock index to treasury bill rate but no short-run linkage. The variance decompositions results showed a strong relative exogeneity of stock index, while the impulse response graphs showed that the response of stock index to shocks in macroeconomic variables didn’t persist for long period. The policy implication of the study is that monetary authority in Nepal would be able to influence the stock market only in the short run, but not in the long run, either directly through its intermediate target (money supply) and its impact on the inflation or indirectly through increased access to the financial services.