Dynamic Relations between Macroeconomic Variables and Indian Stock Price: An Application of ARDL Bounds Testing Approach

Abstract

The purpose of the present study is to examine the dynamic long run and the short run relationship between stock price and a set of macroeconomic variables for Indian economy using monthly data from April 2004 to July 2014. The long run relationship is examined by implementing the ARDL bounds testing approach to co-integration. VECM method is used to test the short and long run causality and Variance Decomposition (VDC) is also used to explore how much the forecast error variance of a conditional stock market volatility is explained by the innovations to each explanatory conditional macroeconomic variables. The results confirm a long run co-integrating relationship among the variables. Evidence suggests that the Index of Industrial Production, inflation and exchange rate influence stock prices positively, whereas, gold price influences the stock price negatively. The VECM result indicates that only long run causality running from all the variables used in the study to stock prices in India. The result of the variance decomposition shows that stock market development in India is mostly explained by its own shocks.