The relationship between stock market and the macroeconomy: evidence from Botswana

Abstract

This study investigates the relationship between macroeconomy and stock market. The specific objectives are to: (a) find out the macroeconomic determinant of stock returns, (b) establish long term relationship of macroeconomic and (c) find out if there are volatility spill overs between macroeconomic volatilities and stock returns volatility. Domestic Company Index (DCI) is used to represent stock returns and (a) Consumer Price Index to represent inflation, (b) USD/BWP as exchange rates, (c) Bank rates as interest rates and (d) M2 to represent money supply as macroeconomic variables. The relevance of Gross Domestic Product (GDP) is highly acknowledged but due to limited data, it was excluded from the study. The study used monthly data of the said variables from January 1994 to December 2014 to investigate the relationship. Classic Linear Regression model is applied to establish the explanatory power of macroeconomic variables on stock returns. Auto-Regressive Distributed Lag (ARDL) is used to find out the long term relationship and lastly GARCH (1,1) is applied to find out if there is volatility spill overs between macroeconomic volatilities and stock returns volatilities. This research established that exchange rates have a negative relationship with stock returns and money supply has a positive relationship with stock returns. It was also noted that there is no long term relationship between macroeconomic variables and stock returns. Lastly, it was noted that inflation volatility and money supply volatility have a spill over effect on stock returns volatility.