Effects of Macroeconomic Variables on Stock Returns - Coursework Example

EFFECTS OF MACROECONOMIC VARIABLES ON STOCK RETURNS Introduction Stock market play a pivotal role towards the economic development of the country.As many researchers have found out that stock market movement have a direct impact on the economic movement (Fox, 2010). Stock market importance has been increased around the world and therefore, many researches have been done in order to explore new avenues regarding the topic. Stock market activities have a direct impact on the financial development and economic growth of the country ( Arestis, et al., 2001). The investors opt to invest in stock market in order to enjoy stock returns. Stock returns are referred as price of stock at the year end, plus the dividend received during the year, divided by the price at the year start (Meyers, 2011, p. 353). Moreover, movement in the stock investment has an impact on stock return; and this movement is affected by various factors and events that effect the economy. However the impact of the factors on stock market may vary from company to company. The factor or macroeconomic variables that affect the stock return includes political situation, interest rate, inflation rate, war, government policies, security conditions, gross domestic product growth rate. However, some factors or events have more impact on returns of certain stocks, while other factors affect the stock returns of all the companies (Lasher, 2013, p. 414) 1.1. Aim of research The aim of the research provides a road map of study and helps the researcher to list down the goals he wants to achieve from the result (Munhall & Chenail, 2008). The main goal of the research is “to analyze the effect of macroeconomic variables on the stock returns”. It is commonly believed that stock market contributes towards the development of the country therefore stock market need to be analyzed in detail in order to get the most out of it. A theoretical study can help in understanding the relationship between macroeconomic variables and stock returns. Therefore, the paper is aimed at studying the effect of macroeconomic variables on stock returns. 1.2. Objectives of research The objectives of the research are determined in a way that break downs the aim of the research to make the analysis more objective and focused and to answer the questions with the help of scientific procedure (Kothari, 2004, p. 2). The major objectives of research are as follows To conduct a theoretical study regarding relationship between the macroeconomic variable and stock return. To determine if macroeconomic variable effect stock returns. To study whether macroeconomic variables have positive or negative impact on the stock returns 1.3. Scope of research The research is trying to achieve the generalized understanding regarding the impact of macroeconomic variables on stock return. The research is useful for all the economists and researchers who are working in the capacity of academic research or professional research. The research will give a better insight to the investors or stockholders regarding the environmental factors that can affect their stock returns. Thus, can help the investors in making the right investment at the right time after properly analyzing the environmental factors. 1.4. Limitations of Research: The major limitation of this research work is that it is theoretical study that is done on the basis of existing literature relevant to the topic. Thus, the conclusion of this theoretical research will be very generic and it may or may not hold true for every country. The reason might be that the certain macroeconomic variables might affect one economy in one way and the other economy in another way. Moreover, it might be the possibility that certain macroeconomic variables in the economy effect stocks of one company in one way and do not affect the other company’s stock at all. Thus, making the research very generic, though will help the future researchers in further extending the research to be more specific context. 2. Literature review This section of the research report is based on the study of already exiting literature relevant to the research topic. The literature review helps in understanding of the researches conducted previously that can help the researcher to derive more better and accurate results. 2.1 Stock Market and Stock Return Capital market plays a significant role towards the growth of the economy (Skousen, 2013). According to Gilani, Nawaz & Nazir (2010), due to increased importance of capital market in the economic growth; all government advisors, industries, companies and central bank keep a close check on stock market activities. Thus, the results elaborated that the stock market can increase the economic growth of the country by two factors; firstly by increasing the size of the stock market and secondly by increasing market capitalization (Gilani, et al., 2010). Therefore, importance of stock market in every economy is undeniable. So, efforts should be done to increase the stock market size; by assuring profitable stock returns to the investors. Hence, all the factors that have their contribution towards the stock return should be studied in detail Studies on factors affecting stock returns have mixed results regarding the contribution and significance of the single independent factor. The reason may be that the in many countries structures of the stock markets are influenced by key players of the markets, who define the stock prices. Investors’ influence may lead to speculative markets which may not be the true representative of the economy (Adams, 1999). 2.2 Stock market and Macroeconomic variables Stock market holds a very significant position in the economy on the country. There are various factors that influence the stock market in a positive or negative way. Macroeconomic variables which impact the stock market include; government policies, exchange rates, inflation, money market, interest rates, foreign direct investments, political instability, gross domestic product growth, security conditions, and judiciary crises. Every variable have an impact on the stock market which in turn effects the stock returns. But every economy is affected differently by each macroeconomic variable. Previously many researches have been done on the impact of macroeconomic variables on stock market. Ibrahim & Aziz (2003) have identified that the most important macroeconomic factors affecting the stock market includes, exchange rate, inflation rate, money supply, foreign exchange reserves, interest rate. But the results of their research indicated that exchange rate and stock prices are inversely related to one another. Thus, when the exchange rates are relatively higher then stock prices goes down in order to attract investors (Ibrahim & Aziz, 2003). Nishat, Shaheen and Hijazi (2004) in their research article “Macroeconomic factors and Pakistani Equity Market”, analyzed the relationship of macroeconomic variables and Pakistan stock market. The variables under their study were money supply, consumer prices index, industrial production and interest rate. Thy found out from their research that stock prices and industrial production have direct and positive relationship between them. Like if the production rate increase then stock prices of the industry will also increase. They also found out that stock prices and inflation rate are inversely proportional, because when the inflation rate is high then stock prices will be high and return will be low (Nishat, et al., 2004). 2.3 Stock return and Macroeconomic variables The relationship between the macroeconomic variables and stock return have been studied by many researchers, analysts and economists. And the studies have indicated that stock return is determined by various macroeconomic variables which includes, inflation rate, interest rate, exchange rate, political conditions, governmental policies etc. Researchers have studied macroeconomic variables and its impact on stock return of various countries (Quadir, 2012). Therefore, we will reviewing significant macroeconomic variables one by one which affect the stock returns; 2.3.1) Inflation Rate and Stock Return Omotor (n.d.) has conducted an extensive study on analyzing the relationship between stock market returns and inflation rate in Nigeria. Time series data regarding Nigerian stock market was collected from 1985 to 2008 in order to study the impact of inflation rates at different time period. The results have shown that the inflation rate is inversely proportional to stock returns which means that when the inflation rate is high then return on stock will be low and vice versa (Omotor, n.d.). Similarly, another study was conducted regarding the effect of inflation rate on stock market return in Greece by Ioannides, Katrakilidis & Lake (2005). The data of stock returns and inflation rate was gather for a tenure of 1985-2000. This research was conducted in order to study both the long term and short term impact of inflation rate on Greek capital market. Therefore, quantitative study was conducted using Granger causality test to analyze the degree and direction of effect on the two variables under study. The results of the research for the long term impact were in support of existing literature which describe that negative relationship exist between inflation rate and stock market returns with regards to long term perspectives (Ioannides, et al., 2005). Moreover, Mogoi (2011) has investigated the linkage between inflation rate and stock return in Nairobi stock exchange market. The research was conducted in order to compare and test the Fisher’s hypothesis (1930), in which he has stated that positive relationship exists between inflation rate and stock market return (Fisher, 1930). A correlation study was conducted to study using time series data of Nairobi stock market from 2004 to 2014. The results of this research were in contradiction to Fisher’s hypothesis and elaborates that negative relationship exists between two variables. Therefore, concluding that inflation rate and changes in inflation rate have a significant negative impact on the stock returns (Mogoi, 2014). Read More