Inter-Linkage between Macroeconomic factors and Stock Market: A comparative study between the U.S and India

It is irrefutable that stock markets provide a barometer that can be relied upon to measure the economic condition of a country. As countries increasingly integrating, there is an urgent need for an ongoing and detailed study of the stock market. The stock market of a country plays a pivotal role in transferring funds from surplus units to deficit units. Any unfavourable news within the stock market may not only impact on market participants but also affect the entire economy. Hence, it is quite essential to recognise the factors that affect market favourably or unfavourably. The empirical literature has provided a set of exhaustive factors with either direct or indirect implications on the stock market. However, this research focusses on domestic Macroeconomic factors, which are projected through the application of the Arbitrage Pricing theory. The key macroeconomic drivers used for this research are Inflation, Interest rates, Treasury Bills, Money supply, GDP and stock returns. The study aims at reflecting upon the exogenous channels through which macroeconomic variables influence the stock market. The study seeks to investigate the relationship between the variables using econometric tests, like ARDL bound test, ARDL short-term and Long-term cointegration tests. Additionally, CUSUM test and Variance decomposition statistical tests were adopted to ensure the stability of the model and to make inferences on the causal relationship among the variables. The analysis began with first differencing the variables, and the results from the tests indicated that all the macroeconomic variables explain the variability in US stock returns in the long run except INDPRO. Whereas LM3 and INDPRO can only explain changes in Indian stock returns in the long term. Both stock markets exhibit the opposite relationship with their own domestic economic variables to some extent. In contrast, the variables behave differently in the short run, and so their relationship with stock returns varies. TB and CPI are the two variables that explain the variation in US stock returns in the short term. Whereas LM3 influences the India stock returns and the rest of the variables demonstrate a weak relationship with stock returns in the short run. The study further extends by investigating the stock returns volatility using ARCH & GARCH techniques which suggested the past stock returns influence the future period stock returns volatility for US and India as well as the results indicated that there is a relationship between the volatility of stock market returns and short-run deviations of the macroeconomic variables for both the countries.