Long Run Relationship between Macroeconomic Indicators and Stock Price: The Case of South Africa

Abstract

This paper examines the long-term equilibrium between South Africa’s stock index and selected macroeconomic variables using vector error-correction models (VECM). Upon testing for co-integration, long run structural equation modelling (LRSM) and VECM, the results indicate that industrial production is the most important determinant of stock market prices. This suggests that South Africa’s stock market is highly sensitive to the country’s industrial production. Money supply, inflation, and exchange rates are other determinants of South Africa’s stock index but to a lesser extent than industrial production. The study found that the macroeconomic variables comprising industrial production, inflation, money supply, and exchange rate are co-integrated on the long run with stock market prices. These findings have implications for policy makers in the sense that any changes in the macroeconomic policy should take into consideration the impact of such changes on the stock market.