Bangladesh Bank Training Academy Journal

Abstract

This paper examines the dynamic causal relationship between capital stock prices and macroeconomic activities in Bangladesh. Though the empirical literature on this issue is voluminous, however for Bangladesh it is quite nascent. Only a handful of studies for Bangladesh [Chowdhury (1995), Mohiuddin et.al. (2006), Rahman and Uddin (2009), Ali (2011), Afzal and Hossain (2011)] has been conducted of which most of them suffer either from omitted variable bias or from the methodological deficiencies. This study is an improvement of the early studies in terms of data used and from methodological point of view. The major objective of this paper is to examine the short run dynamics of the long run relationship between the macrovariables such as the gross domestic product (GDP), money supply (M2), consumer price index (CPI), exchange rate (EXR), interest rate (IR), private sector credit (PSC) on the variability of the stock price (SPI) in Bangladesh. That is to see whether they are cointegrated or not. It also sheds lights on the causal relationship among the considered variables using annual time series data for the period 1985 to 2010. The empirical results show that all the time series data are nonstationary and cointegrated with a single vector. All the explanatory variables have been found to contribute to the long-run equilibrium relationship. The estimation of the error-correction model further confirms the existence of long run stable equilibrium among the variables in the model. It is confirmed that any disequilibrium is corrected by fast adjustment. The Granger causality test also indicates that the lagged change in GDP, M2 and PSC has significant predictive ability for the movements in the stock prices. However, the bidirectional causality has not been established. The implication of the result is that monetary policy has strong stimulus in stabilizing and smooth functioning of the stock market in Bangladesh.