Causality between Stock Market Index and Macroeconomic Variables: A Case Study for Malaysia

The causal relations and dynamic interactions among macroeconomic variables and stock market index are important in the formulation of a country’s macroeconomic policy. In this study, to investigate the lead-lag relationship between stock market index and macroeconomic variables, we employ several conventional time-series techniques and a recently introduced method – wavelet analysis - to economics and finance. The data used in this paper is the monthly data of the selected macroeconomic variables such as (1) Kuala Lumpur Composite Index, (2) exchange rate, (3) inflation, (4) government bond yield, (5) short-term interest rate and (6) export over the period of January 1996 to September 2013. Our findings tend to suggest that a cointegrating relationship does exist between KLCI and selected macroeconomic variables. The results of the error correction model, the generalized variance decompositions as well as the wavelet cross-correlation analysis suggest that the short-term interest rate, KLCI and government bond yields are exogenous variables; especially, the short-term interest rate is the most leading variable. Policy makers may concentrate on the adjustment and control of the short-term interest rate in order to achieve the desired results for the target economic variables.