Stock Prices and the Macro Economy in India

This article studies the relationship between stock prices and the Indian macroeconomy assessed by the level of GDP. There are many different channels of influence between these two variables, channels which may function in either direction. There are also many hypotheses pertinent to these interrelationships. We concentrate on the empirical character of this link, which we analyse within the framework of a VAR/VEC model that allows for two-way interactions but is agnostic regarding the specific theoretical underpinnings, rather than overtly evaluating hypotheses. Using tests for stationarity and cointegration it is discovered that the relationship between stock prices and GDP is cointegrating over the long term. We estimate a VAR model and use variance decomposition. We find that there is strong evidence of long-run causality from the stock market to the economy but not vice versa. We also find modest evidence of a similar short-run effect. We rationalise our results in terms of the relatively small size of India's stock market. It is found that Nifty 50 has strong influence on GDP but GDP does not have any influential effect on Nifty 50 in its forecast error variance. The DCC analysis indicates that there is no integration between GDP and Nifty 50 return in the short run or over long periods.