Dynamic Linkages among Several Macro Economic Variables and Stock Market Returns: An Econometric Investigation using Indian Data

This study investigates the dynamic links between key macroeconomic variables and the performance of stock market in India. With 420 monthly observations and a comprehensive econometric framework, the analysis attempts to assess the impact of Consumer Price Index (CPI), Exchange Rate (EXRATE), Foreign Direct Investment (FDI), and Gross Domestic Product (GDP) on BSE stock returns. Descriptive statistics reveal significant non-normality and volatility, justifying the use of GARCH models to capture market fluctuations. Granger causality and Johansen cointegration tests indicate a unidirectional and long-term influence of macroeconomic factors — particularly FDI, exchange rate, and GDP — on stock returns. Inflation and exchange rate have a positive impact, whereas FDI and GDP show negative associations, highlighting market sensitivity to capital flows and policy conditions. The GARCH (1,1) model accurately describes time-varying stock return volatility. The large ARCH and GARCH coefficients confirm the effects of previous shocks on volatility persistence. Impulse response functions support these conclusions, whereas error correction estimates emphasize the stock market’s role as a shock absorber for the economy. Diagnostics confirm the robustness and structural stability of the model, reflecting the post-liberalization resilience. The research underscores the significant and predominantly unilateral influence of macroeconomic variables on Indian stock markets. It highlights the critical role of a stable macroeconomic framework and investor sentiment in determining market trends.