International Journal of Economics and Financial Issues
Vol. 2, No. 4, 2012, pp.480-487
ISSN: 2146-4138
www.econjournals.com
The Effect of Macroeconomic Variables On Stock Returns
on Dhaka Stock Exchange
Muhammed Monjurul Quadir
73 O’Leary Square, Mile End Road, London, E1 3AR, UK.
Phone: 00442072659951. Email: monjur_ec@yahoo.com
ABSTRACT: This article investigates the effects of macroeconomic variables of treasury bill interest
rate and industrial production on stock returns on Dhaka Stock Exchange for the period between
January 2000 and February 2007 on the basis of monthly time series data using Autoregressive
Integrated Moving Average (ARIMA) model. The paper has taken the overall market stock returns as
an independent variable. It does not consider the stock returns of different companies separately.
Though the ARIMA model finds a positive relationship between Treasury bill interest rate and
industrial production with market stock returns but the coefficients have turned out to be statistically
insignificant.
Keywords: Stock Returns; Macroeconomic Variables; Autoregressive Integrated Moving Average.
JEL Classifications: D11; E32; E37; G12; G32
1. Introduction
The relation between macroeconomic variables and stock return is being continuously studied
by different academic, economists and practitioners (e.g., Chen et al, 1986; Mukherjee and Naka,
1995; Mayasmi and Koh, 2000; Kown and Shin, 1999; Cheung and Ng, 1998; Gjerde and Saettem,
1999) over the last few decades. It is often believed that the stock return is determined by a number of
fundamental macroeconomic variables such as interest rate, industrial production and inflation rate1.
And a good number of studies have captured the effects of macroeconomic variables on stock returns
for different countries. Existing theories offer different models that make available framework for
examining the relationship between stock return and macroeconomic variables2.
The most common approach of linking macroeconomic variables with stock return is through
arbitrage pricing theory (APT) developed by Ross (1976) where multiple risk factor can describe stock
return. Chen et al., (1986) used some macroeconomic variables to explain stock return in the US stock
market and found industrial production, changes in risk premium and changes in term structure were
positively related with the expected stock return but the anticipated and unanticipated inflation rate
were negatively related to the expected stock return.
Another alternative but not inconsistent way of examining the effect of macroeconomic
variables on stock return is the co–integration analysis. For example, Mukherjee and Naka (1995) used
Johansen co-integration test in the Vector Error Correction Model and found Japanese stock market to
be co–integrated with six macroeconomic variables such as exchange rate, money supply, inflation
rate, industrial production, long term government bond rate and the short term call money rate. The
findings of the long term coefficients of the macroeconomic variables are consistent with the
hypothesized equilibrium relationships. Moreover, Mayasmai and Koh (2000) used Johansen co–
integration test in the Vector Error Correction Model and found Singapore stock market to be co–
integrated with five macroeconomic variables.
1 See Fama (1981); Mukherjee and Naka (1995); Chung and Tai (1999); Gay (2008), Christphoer et al., (2006).
2 Two theories are available in literature explaining the effects of macroeconomics variables on stock: Arbitrage
Pricing Theory and Discounted Cash Flow or Present Value Theory. See Humpe and Macmillan (2007).
The Effect of Macroeconomic Variables On Stock Returns on Dhaka Stock Exchange
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Kown and Shin (1999) used Engle-Granger co integration and Granger causality test from the
Vector Error Correction Model (VECM) and noticed the Korean stock market to be co integrated with
a set of macroeconomic variables. Cheung and Ng (1998) used Johansen’s co integration technique
with quarterly data from Canada, Germany, Italy, Japan and the US and concluded that there were
long term co-movements between the national stock index and some specific macroeconomic
variables such as real oil price, real consumption, real money supply and real GNP in those five
countries. Furthermore, the authors found that the stock indices were related to changes in
macroeconomic variables.
The aim of this paper is to examine if the time series analysis of stock market indices of
Dhaka stock exchange is explained by corresponding macroeconomic variables of interest rates and
industrial production. If so, how significant are the relationships and how can they be described? To
answer these questions, this study will examine monthly averages of respective stock market indices,
treasury bill interest rate and industrial production between January 2000 and February 2007. The Box
Jenkins Autoregressive Integrated Moving Average (ARIMA) time series process will be applied to
determine the relationship between the dependent variable( stock return) and independent variables
(industrial production and interest rate). The remainder of this paper is set out as follows: The next
section will provide a theoretical framework of the topic. In section 3, we will provide a brief
overview of the relavent and the data sources and the methodology used in the present study. Section 4
discusses the econometric results and section 5 concludes the paper with some appropriate policy
recommendations.
2. Theoretical Framework
The share market is a place where the shares of different companies are bought and sold.
According to Galbraith (1955) “the stock market is but a mirror which provides an image of the
underlying or fundamental economic condition”. The stock market is often regarded as the barometer
of the economic condition of a state. As per the efficient market hypothesis the price of shares in the
