Cointegration and Causality between Stock Index and Macroeconomic Variables in an Emerging Market

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This study examined the relationship between stock market index and selected macroeconomic variables during the post-financial liberalization (pre-financial crisis) and post-financial crisis in Thailand. In the empirical analysis, unit root, cointegration and Granger causality tests were performed. The post-financial liberalization results showed that the stock market index, the industrial production index, money supply, exchange rate, and world oil prices contained a unit root and were integrated of order one. Johansen cointegration test was then employed. The results showed at least one cointegrating or long-run relation between the stock market index and a set of macroeconomic variables. Money supply had a positive impact on the stock market index while the industrial production index, the exchange rate and oil prices had a negative impact. During the post-financial crisis, all variables were integrated at different orders. Cointegration existed between the stock market index and macroeconomic variables. In addition, the Granger causality test indicated money supply was the only variable positively affecting the stock market returns.


The Stock Exchange of Thailand has been considered an emerging stock market since its inauguration in April 1975. The market capitalization of Thailand Stock Exchange is small while bond trading and other financial innovations have emerged in just the last few years. Like other emerging stock markets in Asia, liberalization in the Thai financial markets, both money and capital markets, reduced the regulation for foreign investors who were interested in investing in Thailand. The financial liberalization in 1992 included lifting capital control measures and allowing banks to lend and borrow more freely in both in- and off-shore transactions. In addition, the Thai government urged capital inflows in both portfolio and foreign direct investment. As a result, the volume of stock trading increased substantially in recent years. Equity instruments are a crucial source of funds for business firms. A continuous increase in private investment via issuing new stocks can be a conduit of GDP expansion and, thus, a high employment rate.

Under the fixed exchange rate regime prior to the financial crisis in 1997, Thailand saw large capital inflows, especially in terms of portfolio investment. This nearly offset the huge current account deficits. Additionally, large capital inflows caused domestic financial institutions to lend a large number of loans to both firms and individual borrowers. The ratio between loans and deposits in the banking system was as high as 1.35 in mid-1990 compared to 0.75 in early 1990. Many analysts believed this was due to the overheating of the Thai economy. In late 1996, private investment accounted for more than 40 percent of the national income. Such phenomena showed that domestic borrowers relied more on foreign capital inflows than domestic savings. During this period, the domestic interest rate rose and caused a wide gap between domestic and foreign interest rates. This interest rate differential induced large capital inflows mostly in portfolio investment. The financial crisis in 1997 had a devastating impact on the Thai economy. A significant effect related to exchange rate risk under the floating exchange rate regime began in July 1 997. Other than real economic activity (e.g., real GDP or the industrial production index) that could affect an investment decision in common stocks, the risk generated from exchange rate fluctuations may also distort the portfolio investment decision. The main objective of this study was to investigate the effects of macroeconomic variables on stock market index/returns in Thailand during the post-financial liberalization prior to the financial crisis (January 1992- June 1997) and after the financial crisis (July 1997-December 2003). The stock market return represents the change in stock market index. …


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