Academic journal article Multinational Business Review

The Effect of Macroeconomic Variables on Stock Market Returns in Developing Markets

Academic journal article Multinational Business Review

The Effect of Macroeconomic Variables on Stock Market Returns in Developing Markets

Article excerpt

The relationship between stock market returns and fundamental economic activities in the United States have been well documented. However, the economic role of the stock markets in relatively less developed Asian countries is less clear. Specifically, how do these less developed markets respond to changes in its fundamental economic variables, when compared to the well developed, well organized, and more efficient markets like the U.S. stock market? The purpose of this study is to investigate the relationship between stock market returns and macroeconomic variables in the Korean stock market, using regression models. We have selected Korea as a case study for developing countries because of its impressive economic growth, liberalization of financial markets, and impending entry into the Organization for Economic Cooperation and Development(OECD). We find the Korean stock market incorporates information on macroeconomic variables in stock returns. The significant factors are the dividend yield, foreign exchange rate, oil price, and money supply. In summary, investors' perceptions of stock returns in the Korean market are quite different from those of U.S. and Japanese investors, suggesting that the Korean market is more sensitive to real economic activities rather than inflation or interest rate variables.

INTRODUCTION

The relationship between stock market returns and fundamental economic activities in the U.S. are well documented [Fama (1970, 1990, 1991)]. In recent years, numerous studies [Fama (1981), Huang and Kracaw (1984), Chen, Roll, and Ross (1986), Pearce and Roley (1988), Fung and Lie (1990), Chen (1991), and Wei and Wong (1992)] modeled the relation between asset prices and real economic activities in terms of production rates, productivity, growth rate of GNP, unemployment, yield spread, interest rates, inflation, dividend yields, etc. However, the economic role of the stock markets in relatively less developed Asian countries (e.g. Korea, Taiwan, Singapore, Hong Kong, Malaysia, China, etc.) is less clear. Specifically, how do these less developed markets respond to changes in its fundamental economic variables, when compared to the well developed, well organized, and more efficient markets like the U.S. stock market?

During the last decade, the Korean stock market has experienced tremendous growth in both trading volume and market value in accordance with rapid economic development. The Korea Stock Exchange (KSE) is one of the most rapidly growing markets in the Pacific Basin and has become the eighth largest stock exchange in the world in terms of market capitalization as of 1990. However, the development of the financial sector in Korea has lagged far behind the real sector of the economy.

Recently, numerous institutional investors and researchers have been focusing their attention on the capital market of the Pacific Basin Countries. The Korea Stock Exchange(KSE) provides an attractive investment opportunity to foreign investors and will play a major role in a global financial market. Moreover, this market has been almost ignored until recently by financial researchers. With the recent government disclosure of financial market opening which will fully abolish ceilings on investments in securities for foreigners by December 2000 , research on the Korea Stock Market is both meaningful and timely for a global financial market.

Since the structure of the Korean stock market differs from that of the U.S., KSE price movements may be different. Even though the KSE is growing rapidly, the market capitalization of the Korean market is much smaller than the U.S. market. Hence, the KSE may be more subject to speculative activities, manipulations, and especially government interventions than the U.S. market. Due to different investor perceptions, is it possible that the KSE responds to economic variables differently than the U.S. market? The main purpose of this study is to test whether current economic activities in Korea can explain stock price variability. …

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