Stock Prices and the Macro Economy in China

This paper analyses the relationship between stock prices and the Chinese macro economy measured by the level of GDP. There are many possible channels of influence between these two variables, channels which may operate in either direction. There are also many theories relevant to these interrelationships. Rather than explicitly testing theories, we focus on the empirical nature of this relationship which we analyse in the context of a VAR/VEC model which allows for two-way influences but is agnostic about the particular theoretical underpinnings. We apply tests for stationarity and cointegration and find that there is a long-run, cointegrating relationship between stock prices and GDP. We estimate a VEC model and use it to analyse both short-run and long-run causality as well as to generate impulse response functions (IRFs). We find that there is strong evidence of long-run causality from the economy to the stock market but not vice versa. We also find modest but weaker evidence of a similar short-run effect. These are borne out by the IRFs which show a small and weak link from the stock market to the economy but a stronger and much more substantial effect in the opposite direction. We rationalise our results in terms of the relatively small size of China’s stock market.