Effect of macroeconomic variables to determine the share market performance in Sri Lanka

Abstract

The stock exchange is considered an economic barometer that emphasises the economic condition of any country. The rise or fall of share prices indicates an economic boom or recession cycle. The better performance of the share market attracts the attention of investors and the exchange of shares continues the process of reinvestment and disinvestment which leads to economic growth via capital formation. The diminishing performance of the share market adversely impacts the creation of investments. It directly impacts economic growth as a component of aggregate demand and as a deterministic factor of the productive capacity of the economy. Thus, the study focused on identifying the effect of macroeconomic variables on the performance of the share market which would attract the attention of economic policy-makers in terms of enhancing the investments within Sri Lanka. The study focused on few key macroeconomic variables as in inflation rate, money supply, treasury bill rate, crude oil prices, gold prices, foreign exchange rate, and analysed the performance of All Share Price Index (ASPI) with those variables. The quantitative research approach was applied for the monthly data collected for 213 months from January 2002 – September 2019. Two factors were derived using Principle Component Factoring as Economic Growth Factor and Time Value of Money Factor. Based on both econometric and time series analysis, the study developed the Vector Autoregressive (VAR) model and the GARCH (1,1) model to analyse the performance of ASPI. The results of VAR model revealed that ASPI data for past months, and time value of money factor which includes inflation and treasury bill rate is more deterministic when analysing the performance of Sri Lankan stock exchange. GARCH (1,1) model also confirmed the same result in its conditional mean equation. However, the economic growth factor shows insignificant result in both the models in relation to the performance of Colombo Stock Exchange.