This study examines the impact of macroeconomic variables on stock prices. We use the Databank stock index to represent the stock market and (a) inward foreign direct investments, (b) the treasury bill rate (as a measure of interest rates), (c) the consumer price index (as a measure of inflation), (d)Average crude oil prices , and (e) the exchange rate as macroeconomic variables. We analyse quarterly data for the above variables from 1991.1 to 2007.4. employing cointegration test, vector error correction models (VECM). These tests examine both long-run and short-run dynamic relationships between the stock market index and the economic variables. The paper established that there is cointegration between macroeconomic variable and Stock prices in Ghana indicating long run relationship. The VECM analyses shows that the lagged values of interest rate and inflation has a significant influence on the stock market. The inward foreign direct investments, the oil prices , and the exchange rate demonstrate weak influence on price changes. In terms of policy implication, the establishment of lead lag relation indicate that the DSI is not informational efficient with respect to interest rate, inflation inward FDI, Exchange rate and world Oil prices.

Do macroeconomic variables play any role in the stock market movement in Ghana

We are in an industry that thrives on the expedient of forecasting the future by extrapolating the past. As a consequence, investors have grown accustomed to the idea that stocks "normally" produce an 8% real return and a 5% risk premium over bonds, compounded annually over many decades. Why? Because long-term historical returns have been in this range, with impressive consistency. Because investors see these same long-term historical numbers, year after year, these expectations are now embedded into the collective psyche of the investment community. Both figures are unrealistic from current market levels. Few have acknowledged that an important part of the lofty real returns of the past has stemmed from rising valuation levels and from high dividend yields which have since diminished. As this article will demonstrate, the long-term forward-looking risk premium is nowhere near the 5% of the past; indeed, it may well be near-zero today, perhaps even negative. Credible studies, in the US and overseas, are now challenging this flawed conventional view, in well-researched studies by Claus and Thomas [2001] and Fama and French [2000, Working Paper], to name just two. Similarly, the long-term forward-looking real return from stocks is nowhere near history's 8%. Our argument will show that, barring unprecedented economic growth or unprecedented growth in earnings as a percentage of the economy, real stock returns will probably be roughly 2-4%, similar to bonds. Indeed, even this low real return figure assumes that current near-record valuation levels are "fair," and likely to remain this high in the years ahead. "Reversion to the mean" would push future real returns lower still. Furthermore, if we examine the historical record, neither the 8% real return nor the 5% risk premium for stocks relative to government bonds has ever been a realistic expectation (except from major market bottoms or at times of crisis, such as wartime). Should investors require an 8% real return, or should a 5% risk premium be necessary to induce an investor to bear stock market risk? These returns and risk premiums are so grand that investors should perhaps have bid them away a long time ago - indeed, they may have done so in the immense bull market of 1982-1999. Intuition suggests that investors should not require such outsize returns, and the historical evidence supports this view. This is a topic meriting careful exploration. After all, according to the Ibbotson data, investors earned 8% real returns over the past 75 years, and stocks have outpaced bonds by nearly 5% over the past 75 years. So, why shouldn't investors have expected these returns in the past and why shouldn't they continue to do so? Expressed in a slightly different way, we examine two questions. First, can we derive an objective estimate of what investors should have had good reasons to have expected in the past? And, why should we expect less in the future than we've earned in the past? The answers to both questions lie in the difference between the observed excess return and the prospective risk premium, two fundamentally different concepts that unfortunately carry the same label, "risk premium." If we distinguish between past excess returns and future expected risk premiums, it is not at all unreasonable that the future risk premiums should be different from past excess returns. This is a complex topic, requiring several careful steps to evaluate correctly. To gauge the risk premium for stocks relative to bonds, we need an expected real stock return and an expected real bond return. To gauge the expected real bond return, we need both bond yields and an estimate of expected inflation through history. To gauge the expected real stock return, we need both stock dividend yields and an estimate of expected real dividend growth. Accordingly, we go through each of these steps, in reverse order, to form the building blocks for the final goal: an estimate of the objective, forward-looking equity risk premium, relative to bonds, through history.

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What Risk Premium is 'Normal'?

The association between interest rate changes and stock returns has long been of interest to investors, all the more so recently as investors and the financial and popular press have zeroed in on the effect of Federal Reserve actions on interest rates. The interest rate sensitivity of common stocks can be measured using an alternative specification of duration, empirical duration, a measure that has become accepted by fixed-income analysts and portfolio managers. Analysis of the interest rate sensitivity of the aggregate stock market considers alternative economic sectors and many industries and stock indexes that reflect different sizes and investment styles. Five important results are documented: 1) dramatic changes over time in the empirical duration of common stocks; 2) substantial differences in the total-period empirical duration for different economic sectors and different industries; 3) a significant negative relation between market risk and interest rate risk for different industries; 4) significantly different patterns of empirical duration over time for different sectors and industries; and 5) differences in interest rate sensitivity for various economic sectors, industries, and investment styles that are generally consistent with economic expectations.

Analysis of the Interest Rate Sensitivity of Common Stocks

This study is focussed on estimating the real interest and inflation sensitivity in Spanish market, proposing an extension of the Stone (1974) two-factor model and controlling for size and growth of the companies [Fama and French (1993) three-factor model], because of its importance in the stock sensitivity shown by previous literature. I also study the classical explanatory factors of the stock sensitivity: leverage and liquidity level of the firms. The Spanish stock response is similar to the response in other markets, and the ‘size’ is higher than ‘growth’ effect.

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Spanish stock market sensitivity to real interest and inflation rates: an extension of the Stone two-factor model with factors of the Fama and French three-factor model

Our paper considers an extension of duration, a standard measure of the price volatility of a bond as defined in the fixed income literature, to equity securities. Fund managers typically use duration in their investment schedules as a method of matching fixed income instruments against known contractual liabilities. Thus immunisation, as first recognised by Redington (1952), was defined as “the investment of the assets in such a way that the existing business is immune to a general change in the rate of interest”. Immunisation corresponds not only to the matching of assets with the present value of liabilities, as formalised by Fisher and Weil (1971), but also to the replication of the interest rates sensitivities themselves, as discussed in Bierwag, Kaufman and Toevs (1983). This creates an ostensibly immunised frontier position, or fund surplus, against stochastic changes in interest rates, which consequently have no effect on final valuation. Matching liabilities in this manner adds value directly, by allowing corporate management to focus on their core business, while simultaneously allowing shareholders and future pension recipients to monitor the level of available funds more precisely. International accounting standards enforce a mark-to-market convention for pension fund reporting, thereby exacerbating the need for an improved methodology for quantifying equity duration risk. In the fixed income literature, Macaulay (1938) first defined what subsequently became known as Macaulay duration 2 , as the weighted average term to maturity of the cash flow of a bond. The weights are simply the present values of each of the anticipated cash flows, both coupons and principal, as a percentage of the price of the bond. Macaulay chose each cash flow’s contribution to the total price as its weight, which although somewhat arbitrary, remains extremely close to the measure in use today. Duration has been subsequently defined by Fabozzi (1997) as “the approximate percentage change in the price of a bond or bond portfolio to a 100 basis point (1%) change in yields”. Hence, the concept of duration expresses the amount by which price fluctuates with respect to changes in underlying bond yields 3 .

The derivation of a new model of equity duration

(1989). A Total Differential Approach to Equity Duration. Financial Analysts Journal: Vol. 45, No. 5, pp. 30-37.

https://www.jstor.org/stable/pdfplus/4479256.pdf

H. Nicholas Hanson

Papers

A Total Differential Approach to Equity Duration