Do Exogenous Shocks in Macroeconomic Variables Respond to Changes in Stock Prices?

Abstract

The purpose of the study is to examine unexpected changes in stock prices due to external shocks caused by macroeconomic variables to predict future stock market returns. The authors apply two econometric models, Variance Decomposition (VDC) and Impulse Response Function (IRF), to study how external shocks in macroeconomic variables affect changes in stock prices. Monthly time series data of five significant macroeconomic variables: real exchange rate, interest rate, consumer price index (CPI), crude oil price and trade openness are taken as independent variables and BSE SENSEX as dependent variable. The study period is from January 2009 to December 2019. There is some strong evidence of changes in stock prices due to exogenous shocks related to exchange rate, trade openness, inflation and interest rate along with crude oil prices. According to the results obtained, changes in the stock market are caused by external factors, such as changes in dividend policy or capital losses, and some changes in the stock market are caused by their own innovation shocks. The authors recommend that companies control capital losses and focus on stable earnings/dividend policies to reduce the frequency of unexpected stock price changes. The literature review presents various opinions in the context of measures of these variables, but no study has been conducted on exogenous shocks to macroeconomic variables on BSE SENSEX for Indian stock market with such specific data set and duration.