Causal Relationship between Macroeconomic Variables and Sri Lankan Share Market Index

Ruwanga Wijesooriya

Ruwanga Wijesooriya University of Sri Jayewardenepura, Faculty of Management Studies and Commerce

Keywords: Macroeconomic variables, Share Price Index, Colombo Stock Exchange, Granger Causality, Market Efficiency

Abstract

This study intends to identify the availability and nature of causal relations between macroeconomic variables and Sri Lankan share market index by analysing monthly data for the period of 11 years starting from 2007 to 2017. Total imports (IMP), Three months government treasury bill rate (TBR), Foreign exchange rate (EXR) and Inflation rate (WPI) variables have been employed to reflect the macroeconomic impact along with All share price index (ASPI) of Colombo Stock Exchange (CSE) to indicate the stock performance. Granger causality test is the fundamental econometrics technique applied to derive conclusions on the causal relations and it resulted with one bi-directional causality between IMP and ASPI variables at 5% level of significance. However, availability of bi-directional causal relations violates the efficient market hypothesis assumed by Fama (1970) since it enables investors to develop profitable trading rules to predict future stock prices. Therefore, CSE fails to maintain informational efficiency as observed by many of the previous studies.

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