Causal Relationship between Macroeconomic Variables: Evidence from Developing Economy

Importance of stock market in the economic development of a country cannot be denied, and macroeconomic variables are important indicators that affect stock market of a country. Present study provides a great contribution to understand the association of these variables with stock market. This paper deals with the causal relationship among KSE 100 index and interest rate, exchange rate, consumer price index, imports and exports. For this purpose data of nineteen years has been collected from 1992 to 2010. Techniques of Augmented Dickey-Fuller test, regression analysis and Granger Causality test have been applied to examine the causal relationship of selected macroeconomic variables with KSE 100 index. Results of regression analysis indicate the presence of strong positive relation between IMP and KSEI. <br><br>Furthermore, interest rate, exchange rate, consumer price index and exports have no relationship with KSE 100 index. Results of Granger Causality test demonstrate that bi-directional relationship exists between interest rate and KSE 100 index. Exchange rate and imports have uni-directional relationship with KSE 100 index and no causal relationship exists between consumer price index, exports and KSE 100 index. Present study provides valuable contribution in knowledge. It is important and attractive not only for investors but also for policy makers.