Economic Indicators' Impact on Different Stock Categories - Research Paper Example

While every indicator is an important measure of a facet of the economy, do all of them influence the stock markets equally? Hence the importance to know is which of these indicators influence the stock markets most, and probably more importantly which economic indicators most influence which types of stocks. For an investor, knowing which key economic affect the stock prices most can be of paramount importance, especially if they are in the stock market for the short-term. Different families of stocks provide different returns, which means that different investors, based on their appetite for risk, will opt for different investment strategies for which type of stocks to keep in their investment portfolio.

This means that a “one-size fits all' theory on economic indicators affecting the stock prices may not be particularly relevant. Hence the need to identify whether (or not) the same set of economic indicators similarly influence the stock prices of small cap stocks as for large cap stocks. Finally, a revelation from research that the small cap stocks are indeed influenced differently and/or by different economic indicators than those for large cap stocks, could have significant implications for governments - especially in formulating their economic policies with regard to small cap companies and even start-ups in the country.

2 Literature Review Stock markets depend a lot on the economic activity in the country. The health of the economic activity is presented through the economic indicators. Several studies have therefore been done on the linkage between stock markets and macroeconomic variables. While some studies have focussed on industrialised and developed economies others have focussed on the developing economies. Also, while some studies have attempted to see the impact of one macroeconomic variable on the stock prices, others have used two or more variables to see the link between macroeconomic variables and stock markets.

Some of the economic indicators that influence stock prices as suggested in various studies include: Inflation, Unemployment, Interest Rates, Exchange Rates, Gross Domestic Product (GDP), Industrial Production, M2 Money Supply, and so forth. The subject of how economic indicators influence stock prices or stock returns has been studied regularly over the years. Ibrahim (1999) found that macroeconomic forces have systematic influences on stock prices via their influences on expected future cash flows.

Chakravarty (2005) also viewed that stock exchange prices are highly sensitive to fundamental macroeconomic indicators. Mehr (2005) observed that the effects of public policies on economic growth can be measured by the increase in stock exchange prices. Some of the other researches to have been conducted on studying the link between one or a combination of several economic indicators and stock markets are Feldstein (1983), Thorbecke and Coppock (1995), Chang, Yeung, & Yip (2000), Sellin (2001), Boyd, Hu & Jaganathan (2002), Tessarotis (2002), Bernanke & Kenneth (2005), Desislava (2005), Vygodina (2006), Maskay (2007), Bartolini, Goldberg & Sacarny (2008), Mahmudul & Gazi (2009).

These studies have dealt with the subject with different approaches - from considering one of the economic indicator’s effect on stock market to considering a bunch of up to 25 economic indicato