Impact of the Macroeconomic Variables on All Share Price Index in Colombo Stock Exchange, Sri Lanka: GARCH-X Approach

Abstract

This study examined the dynamic impact of macroeconomic variables on All Share Price Index (ASPI) volatility. Data were collected for the period spanning from January 2006 to December 2015 using annual reports of the Central Bank of Sri Lanka and publications of Colombo Stock Exchange. Money supply, interest rate, consumer price index, exchange rate, and industrial production index were used as macroeconomic variables of the study. The AR (1) - GARCH (1, 1) - X model was identified as the significant model to model volatility of all share price index. It was found that the previous all share price index (lag 1) positively and significantly affects the current ASPI implying that the volatility of stock market prices is affected by related news from the previous period more than by past volatility. Negative values of two parameters of the GARCH indicate that shocks to the conditional variance take a short time to die out, so volatility is not persistent. The result further implies that the volatility in interest rate and industrial production index have significant impact for the volatility of all share price index. The Johansen-Juselius cointegration test suggested that macroeconomic variables in the system share a long run relationship. Results imply that, ASPI has significant positive long run relationships with money supply, interest rate and exchange rate while significant negative long run relationships with industrial production index and consumer price index. Investors in the stock market should look at the systematic risks revealed by the macroeconomic variables when structuring portfolios and diversification strategies.