The Effect of Macroeconomic Variables

The relationship between macroeconomic variables and stock prices has been extensively studied by Boudoukh and Richardson (1993), Solnik and Solnik (1997), Engsted and Tanggaard (2002), Kim and In (2005), and Schotman and Schweitzer (2000). This is especially so for the developed capital markets, and the literature on these variables are widely available. Various multifactor models have thus been developed as an explanatory factor of the variation in equity prices. These studies have typically focused on developed markets. The relationship between macroeconomic variables and stock prices has been examined in the Emerging Stock Markets (ESMs) especially since 1980s. It is also evident that the interest of investing in the emerging markets has grown considerably over the past decade. Harvey (1995), for example, observes that returns and risks in ESMs have been higher, relative to other developed markets.

Many scholars have focused their studies on establishing what causes movements in stock prices. Most of their findings point out to the existence of a strong relation linking the price of stocks and macroeconomic variables. This is especially so in developed economies like that of the United Kingdom. Even though a number of researches were done in new markets, there is little evident that such have been done in regard to the London Stock Exchange (LSE). Some of exceptional researches on the LSE are those that were done by Samarakoon (1996, 1998, 1998); Samarakoon (2000); Nimal (1997), Poon and Taylor (1997), and Premawardena (1997). This study aims at extending their findings in considering the link between stock prices and macroeconomic variables in the UK Stock Market. It will, thus, consider a number of macroeconomic variables already discussed by these scholars in making inferences to the effects of these variables on the stock prices. From their findings, it is evident that there is a notable relation between prices of stock and the macroeconomic variables in the London Stock Exchange and indeed in any other stock exchange around the world.

Several hypothetical inspirations prompted the carrying out of this study. The first is that the relationship between movements in the rate of exchange and the prices of stock depends on the increase in domestic interest rate. It has the effect of initiating capital inflows resulting in the increased exchange rate. This means that, for industries that rely on exports, appreciating in currency influences negatively price of stock in those industries since the exports become dwindled. In contrast, appreciation of currency enhances the stock market, thus implying a positive impact on the stock prices. It is especially notable in the industries that depend on import since this has the effect of increasing the import levels.

The studies conducted on the link between stock prices and interest rates in the developed capital markets indicate that stock and returns on bonds can be predicted (Samarakoon (1996, 1998, 1998); Samarakoon et al (2000); Poon and Taylor (1997); Nimal (1997), and Premawardena (1997). The studies also revealed a correlation between the two variables in forecasting their movements. The major finding was that there is a strong relationship between these two factors to the effect that an increase in securities in treasury tended to cause investors to withdraw from the stock market and consequently to reduce the stock prices (Ely and Robinson 1997). Evidently, the inflation is a major macroeconomic variable that has formed a theoretical approach for a long time.

Ultimately, Gallagher and Taylor (2002) noted that the fundamental theoretical concept in this part is usually accorded to Irving Fisher who argued that the ostensible interest rate fully reveals the accessible information concerning the potential values of the rate in inflation. Many scholars of economics conquer with this supposition ((Wiedmann (2011), Poon and Taylor (1997), Nimal (1997), and Premawardena (1997)). Thus, Fisher’s findings form an important tool in establishing the effects of macroeconomics on the stock prices, financial matters, and even understanding monetary theories. As such, these factors form the basis of this study on the London Stock Exchange.

The above-mentioned theoretical inspirations and experimental evidence show a relation between the stock prices and macroeconomic variables. With the need to have a clear understanding of this relationship, economists feel that macroeconomic variables should increasingly be explored. The intention of these explorations is to document effects of stock prices in the London Stock Exchange. With consideration of the above facts, the researcher hopes that the findings of this study will be of interest to a number of groups, together with holding practical implications for the groups.  As such, it is clear that this study is timely and essential.

Stock exchanges all over the world form the uppermost market for capital. Clearly, a well-developed capital market is important in promoting the economic development that the UK so desperately needs. The government of the United Kingdom has been offering several incentives to improve the performance of the stock market. To be more specifically, foreign investors are given significant incentives to invest in the UK company shares. Furtherance to this, the UK government has taken several momentous steps to guarantee that companies listed on the London Stock Exchange get involved in the development of infrastructures. These infrastructures include but not limited to areas like the electricity, telecommunication, water, and sanitation. With consideration of the above factors, the findings of a study of this nature will arguably be of enormous consequence for both local and foreign investors. Stock market regulators, multinational corporations, stock market analysts, and policy-makers are also poised to benefit immensely from its findings. As a result, this particular study is very vital for promoting steps to enhance the UK Stock Market. Moreover, the capital market plays an important part in the economy, and companies, hence should be studied exhaustively.

Still, the dearth of literature on the effects of macroeconomic variables on the stock prices and little attention of the responsible parties together with the inadequate knowledge of this issue in the UK context could not be added to the information set available to the above parties. This study will add some vital information to the existing literature concerning the UK Stock Market. Consequently, the research problem of this study hinges on finding out whether there is any link between macroeconomic variables and stock prices in the London Stock Exchange and how this link can be determined in terms of influence on the stock prices.

The chief objective of the study is to make out the influence of macroeconomic variables behaviours on the stock prices. The rest of the paper continues as indicated below; Chapter 2 reviews the literature concerning the topic; Chapter 3 describes the methodological issues and data used; and Chapter 4 discusses the results. Chapter 5 analyses the pragmatic findings of the study, while Chapter 6 makes conclusions in regard to this study. The final chapter is the reflections inferred from this study.

The results of this study have implications for both local and foreign investors, stock market regulators, such as the Securities and Exchange Commission, policy makers, stock market analysts, and the government of the United Kingdom. Using the findings of this study, investors and security analysts could predict stock prices and earn profits, and the Bank of England could come up with better policies to manage the macroeconomic variables in the country. Stock market regulators could take steps to monitor the activities of companies to prevent manipulation of stock prices, get the public educated on the stock market, and encourage them to invest in stocks. Policy makers should be aware of these macroeconomic effects on the stock market and make their decisions in a more effective and accurate way.

The results of this study are based on the data sets, which are of high quality. Future researchers can investigate the effect of macroeconomic variables on stock prices using alternative methodologies and using sectored share price indices. Furthermore, they should consider using data with various frequencies such as daily and weekly. The result should then be examined to know whether they are sensitive to the frequency of data. Other aspects on which future researchers can concentrate on are the longer periods and larger sample sizes with greater numbers of sectors using other macroeconomic and non-macroeconomic variables.

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