Do Indian stock prices respond to domestic macroeconomic variables?

The volatility in the Indian stock markets in the last couple of decades has raised a pertinent question – are these meaningful institutions that are linked to the overall macroeconomic health of the country or are they mere casinos where people make and lose millions? Keeping in mind this question, the present study investigated the effect of a subset of macroeconomic variables on the Indian stock market. The study uses monthly time series data covering the period from April 2005 to December 2019 and employs the ADF unit root test, Johansen cointegration test, VECM, and Granger causality for data analysis. Variance decomposition analysis has also been performed to determine the significance of each variable in generating fluctuations in other variables. The results show that the macroeconomic variables are co-integrated with the stock prices suggesting the presence of a long-run relationship. The pairwise Granger causality test indicates that the exchange rate, money supply, and short-term interest rate granger cause stock prices. The VDC analysis indicates that stock prices in India are relatively exogenous in relation to other macroeconomic variables. The study concludes that volatility in stock prices in the future to a certain extent can be forecasted by the information prov ided by the selected macroeconomic fundamentals.
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