Stock Markets and Real Economic Activity : Zooming out to show a broader picture using 12 EU Membership Countries

University essay from Högskolan i Jönköping/IHH, Nationalekonomi

Abstract: This thesis analyzes the long run relationship between stock markets and macroeconomic variables, such as the real industrial production index, consumer price index, money supply, and long-term government bonds. By the use of recent developments in cointegration methodologies a larger set of countries is analyzed due to mitigation of the issue where variables are integrated of different orders. Based on a present value model, this thesis applies an ARDL model and conducts the bounds testing procedure for analysis of cointegrating relationships among the variables. Complemented by the popular Johansen cointegration methodology, it is found that the variables are cointegrated for all of the twelve countries. Hence, the present value model provides a theoretical explanation of the long run connection between stock markets and macroeconomic variables. Finally, the long run relationship is estimated using both FMOLS and DOLS. Results show that real economic activity, proxied by the real industrial production index, enters a positive relationship with the stock market indices, and so does money supply. In contrast, the consumer price index and long-term government bonds enter a negative relationship with the stock market indices. Hence, this thesis adds to the literature by applying new methodologies to the topic, through which a larger set of countries can be analyzed, and by further analyzing the long run relationship between stock markets and real economic activity.

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