Academic journal article Journal of Financial Management & Analysis

Linkage between Stock Market and Macroeconomic Fundamentals: Case Study of Athens Stock Exchange

Academic journal article Journal of Financial Management & Analysis

Linkage between Stock Market and Macroeconomic Fundamentals: Case Study of Athens Stock Exchange

Article excerpt


In recent years, the effects of fundamental macroeconomic news on stock price movements have received a considerable attention. The role that macroeconomic news play in explaining the movements in stock prices is very important both for practitioners and academic researchers. Practitioners are perhaps interested in using the information about macroeconomic fundamentals in pricing assets or alternatively making decisions about real investments. On the other hand, academic economists may be interested because this will help them to identify some sources of systemic risks, and to consider whether these risks are priced (as the should) on the stock market.

The news approach is based on the efficient market hypothesis, which attributed movements in asset prices to new information (hat effects either the expected future cash flows or the expected discount rates at which those cash flows are capitalized, or both. According to Fama1, a stock market is efficient if current market prices fully and instantaneously reflect all available information. Another important aspect is that the expected or past information contains no new information and therefore should have no effect on stock prices, since this information has already been incorporated into prevailing market prices. Hence, the implication of market efficiency is that if economic agents are careful users of available information, then stock price changes can only be due to news, about, for example, macroeconomic fundamentals.

There is a branch of economic studies testing the relevance of macro-economic news for stock price movements. The empirical evidence (eg. see Pearce and Roley2; Hardouvelis3; Wasserfallcn4; Aggarwal and Shirm5; Sadeghi6; McQueen and Roley7; Siklos and Anusiewicz8; and Ewing9) suggests that stock returns respond to news, However, these results show that news can only explain a small fraction of observed variations in equity returns (Roll10 and Cutler, Poterba and Summers"), even some of the influences are significant at conventional levels. In general, these results indicate that stock returns primarily respond to monetary news while non-monetary news seems to have only weaker effects. The empirical evidence also seems to be sample-specific and unstable over time (Orphanides12).

The objective of this paper is to investigate the causal relations among macro-economic variables such as:

* Inflation

* Interest rates

* Industrial production

and the stock market index in the small and open Greek economy, where financial markets are less mature as compared to those in eg US, Japan and the UK.

The paper concentrates on the relationship between macro economy and the stock market in Greece by asking the following questions:

1. Does GEN cause the index of industrial production (IPI)?

2. Do interest rates (RFR) cause GEN?

3. Does inflation (INF) cause the industrial production index?

4. Does industrial production cause inflation?

5. Does inflation cause interest rates?

6. Does GEN cause inflation?

7. Does industrial production cause interest rates?

8. Does Gen cause interest rates?

9. Does industrial production cause GEN?

10. Do interest rates cause inflation?

11. Does inflation cause GEN?

12. Do interest rates cause industrial production?


Without a precise economic theory that explains the link between macro-economy and the stock market, the decision about which fundamental economic variables are to be included in the analysis is somewhat arbitrarily. In reality several factors may have impacts on stock prices. Therefore, some simplifying assumptions about investors' relevant information set as a proxy for the true information set are required. However, since this paper deals with a small open economy, the following macroeconomic indicators are required to describe both real and financial conditions of the domestic economy:

1) Logarithm of Industrial Production Index, (IPI), is included as a proxy for real economic activity in the Greek market, since the weight of the stock market is accounted for by services, utilities, public and semi-public firms. …

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