Stock Price and Industrial Production in Developing Countries: A Dynamic Heterogeneous Panel Analysis

As an investor, we are interested in the relationship between economic and financial indicators. For this, for the investor, it is of utmost importance to identify the correct model for the long run and short run relationship, as this will determine the timing of entering and exiting the stock market. In this paper we investigate the correlation between the real stock price and the real industrial production index. The estimation of correlation coefficient would involve the panel data of nine (9) developing countries, including the four (4) BRIC countries, using data for the period 2008 to 2010. We employed the panel unit root test and panel cointegration tests using Eviews. We then proceed with the estimation of Fixed Effect (FE), Random Effect (RE), Pool Mean Group (PMG) and the Mean Group (MG) using Stata II command. The application of the heterogeneous panel model of Pool Mean Group (PMG) and the Mean Group (MG) – Im,Pesaran,Smith (IPS,1999) will allow for the heterogeneity effect among the different economies. Our findings proved that RE is superior to FE due to the inconsistency problem, which is the existence of correlation between missing cross sectional variables with the explanatory/regressor variables. The Hausman test performed supported this finding. We observed that the slope coefficients indicate a negative relationship between real industrial production and real stock price. Again, although both PMG and MG are consistent, Hausman test proved that MG is inefficient, and thus PMG is chosen for the final estimation. Finally, while we found out that in the short run the coefficient of industrial production varies with each country, they were the same in the long run.