The short-run and long-run relationships between macroeconomic variables and stock prices : empirical evidence from the Malta stock exchange

Abstract

This study investigates the short-run and long-run associations between macroeconomic variables and stock prices in Malta using monthly data from January 2000 to December 2019. This study is motivated by inconsistencies in earlier studies about the nexus between stock prices and macroeconomic variables in both the short-run and long-run, and due to the scarcity of research on this topic concerning Malta. Previous research provides differing conclusions, attributable to the different economies, proxies, variables and periods explored in such studies. After reviewing the literature, the variables chosen for the study include inflation, money supply, industrial production index and interest rates. To reach the study’s objectives, a quantitative methodology via time series analysis techniques is employed. Unit root tests to test for stationarity are used, followed by a cointegration test via the ARDL Bounds test to determine the presence of a long-run relationship between the variables. Next, an ARDL model is estimated to estimate the short-run and long-run relationships. Findings indicate that all variables are integrated at order 1 and a long-run relationship is found between the variables. Maltese stock prices are influenced negatively by 2 months lagged inflation in the short-term. However, an insignificant and positive relationship is found in the long-term. A significant and negative link is also established between money supply and stock prices in the short-run and long-run. Stock prices are positively related to 3 months lagged short-term interest rates and negatively related to long-term interest rates. Lastly, a highly insignificant and negative relationship is found between industrial production index and stock prices. Findings suggest that investors interested in the Maltese market should incorporate inflation, money supply and interest rates in their investment decision making, whereas policymakers should exercise constructive impact on the economy so that investors expect reduced volatility in the stock market, thereby ameliorating investors’ confidence.