Macroeconomic Determinants of Stock Market Performances in Sri Lanka

Abstract

This study measures the impact of the macroeconomic variables on the All-Share Price Index (ASPI) of the Colombo stock exchange in Sri Lanka. Monthly data collected from the CSE data library and the Central Bank of Sri Lanka publications from 2008 to 2020 were employed.  The dependent variable is the All-Share Price Index (ASPI) and the independent macroeconomic variables are gross domestic production (GDP), interest rate, exchange rate, inflation rate, money supply, and reserve money. The Augmented Dickey-Fuller test was employed to test for stationarity and the results indicate that all the variables are integrated in the same order I (1).The co-integration analysis for the selected macroeconomic variables and ASPI were carried out to test for the existence of the long-run relationship and the Vector Error Correction Model (VECM). The Johansen co-integration test and the VECM have been performed in this study. The multivariate regression analysis was performed using the selected six independent macroeconomic variables on ASPI and the parameters were estimated using Ordinary Least Square (OLS) method. The results indicate that the selected economic variables have an overall impact on the ASPI of Sri Lanka. Interest rate, exchange rate, and money supply affected negatively on ASPI while gross domestic production, inflation rate, and reserve money reacted positively on the ASPI. The VECM shows that the GDP has had a significant impact on the growth of ASPI in the last two months. The results of the Granger Causality test indicate that the ASPI has a unidirectional causal relationship with the exchange rate, also the exchange rate and interest rate have a significant bidirectional causality on each other at 1% and 5% levels. Furthermore, the GDP has a unidirectional causal relationship with the interest rate as well as money supply has a unidirectional causal relationship with the exchange rate, and reserve money and money supply variables have a significant bidirectional causality with each other at 10% significance level. Finally, the study concluded that at 10% significance level, all the variables have a significant impact on the ASPI of Sri Lanka and the inflation rate has a comparatively higher effect on the ASPI.