STOCK RETURN AND MACROECONOMIC FUNDAMENTALS IN MODEL- SPECIFICATION FRAMEWORK : EVIDENCE FROM INDIAN STOCK MARKET

Abstract

This paper presents a systematic analysis of monthly return data for studying the influence of macroeconomic fundamentals in explaining variations in Indian stock returns with due considerations being given on both linear and higher –order autocorrelations of returns as well on proper specification of both the conditional mean and conditional variances. Using several autocorrelation-based tests we found significant evidence of both the first and second order dependences in monthly stock returns, and hence rejection of weak-form efficiency for the Indian stock market. As regards the return data analysis in appropriate model-specification framework Hansen test and Chow test were first used, and a break in the structural relationship was found to have occurred during the first half of 1995. This finding may be attributed to the effect of economic liberalization programme initiated in the early ‘90s by India. Thereafter all possible relevant macro variables were considered in the context of our study of the relation between stock returns and macro variables, and the following variables viz., real economic activity, growth in money supply, inflation, foreign capital market activity and foreign direct investment were finally found to have significant effects on monthly returns in the post-liberalization period. Moreover, the analysis based on BDS test suggests that nonlinear dependence in the form of ARCH/GARCH model is not adequate, and

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