Macroeconomic Determinants of Stock Returns

Knowledge of sensitivity of stock returns is important for investment, trade and financial issues. It provides insights on stock market dynamics that are useful for policy makers, investors and traders. Using monthly data for the period January 2007 to April 2012, this study examines the stock returns sensitivity to four key macroeconomic variables namely industrial production, exports, exchange rate and interest rate. Index of industrial production and interest rate are significantly related to stock prices in the long run. It implies that growth in the real sector leads to the better returns in the financial sector as well. One possible explanation could be that well-performing real sector builds strong sentiments or expectations in the economy which drive stock returns. It also indicates that stock returns are driven by domestic industrial production rather than exports. The significant interest rate implies that monetary policy measures are crucial in determining the returns in the stock market in India.