Economic fundamentals and stock market behavior: an empirical study

Abstract

Changes in economic fundamentals as represented by some macroeconomic variables such as GDP growth rate, industrial production, inflation and others will affect stock prices as these changes will affect the expected future cash flows of the firms. Most of the previous studies used models that did not capture the long-run relationships between the stock prices and the macroeconomic variables. In this study, we use Engle-Granger Cointegration approach to investigate bivariate cointegration between KLSE composite index and macroeconomic variable to explore their long-run relationship. Pairs of composite index and macroeconomic variable that are found to be cointegrated are then tested for Granger causality. It is found that consumer price index, M3 and industrial production index can predict composite index. However, industrial production index can also be predicted by the composite index.