Abstract:
This study investigates the effects of macroeconomic variables on stock prices in
emerging Sri Lankan stock market using monthly data for the period from
September 1991 to December 2002. The multivariate regression was run using
eight macroeconomic variables for each individual stock. The null hypothesis
which states that money supply, exchange rate, inflation rate and interest rate
variables collectively do not accord any impact on equity prices is rejected at
0.05 level of significance in all stocks.
The results indicate that most of the companies report a higher R2 which justifies
higher explanatory power of macroeconomic variables in explaining stock prices.
Consistent with similar results of the developed as well as emerging market
studies, inflation rate and exchange rate react mainly negatively to stock prices in
the Colombo Stock Exchange (CSE). The negative effect of Treasury bill rate
implies that whenever the interest rate on Treasury securities rise, investors tend
to switch out of stocks causing stock prices to fall. However, lagged money
supply variables do not appear to have a strong prediction of movements of stock
prices while stocks do not provide effective hedge against inflation specially in
Manufacturing, Trading and Diversified sectors in the CSE. These findings hold
practical implications for policy makers, stock market regulators, investors and
stock market analysts.
