Monetary variables and Stock Market Returns – The Indian Experience

Abstract

There seem some astute annotations by economists and researchers on the causal relationship between monetary variables and performance of the equity markets. The foundation of this assertion refers to the flow of money supply and changes in interest rates and inflation that leads to the investment impact in equity markets. Indian economy is very much influenced by inflation and the monetary policies adopted by the Reserve Bank of India. There was a need to explore this policy impact on the Indian stock market, keeping in view the inflation factor also. This article aspires to identify the direction of causality between monetary variables such as money supply, consumer price index, call money rate and the performance of the Bombay Stock Exchange in VAR model. Impulse response function and variance decomposition analysis were employed to estimate the shock create by macro factors like money supply, interest rates and inflation on equity returns. There is a long-run relation exist between monetary variables and BSE Sensex. In the short run, however, there exists a unidirectional causality for consumer price index to performance of equity market. This implies that the inflation affects the movement of equity market in India in short-run. The paper restricted to only three macroeconomic variables although these are not the only macroeconomic factors which affect the stock prices in India.