The effect of selected macroeconomic variables on stock market returns of the Malawi stock exchange

Abstract

Financial theories posit that stock prices are influenced by a number of macroeconomic variables such as interest rates and exchange rates. For instance, economic theory postulates that stock prices and interest rates are inversely related and that fluctuations in exchange rates cause movements in stock market returns. These theories are based on the view that stock prices represent the present value of discounted future cash flows and therefore any events affecting a firm‟s cash flows should be reflected in the firm‟s stock price. The objective of the study was to investigate the effect of selected macroeconomic variables on the market returns of the Malawi Stock Exchange. After noting the inadequacy of the Ordinary Least Squares (OLS) regression framework, a GARCH (1, 1) model was employed in analysing the data. GARCH models usually work well in instances where data is characterised by „volatility clustering‟. Weekly data for the variables was used. Findings from the study confirmed that the macroeconomic variables of interest rates and exchange rates have an impact on the market returns of the MSE. Interest rates and exchange rates affected both the market mean returns as well as the volatility of such returns on the MSE. In line with these findings, some of the policy recommendations were that policy makers should seek to implement policies that do not adversely affect investors and other economic agents. Strategies should be put in place to achieve desired fiscal and monetary objectives without unduly influencing stock prices on the MSE. The study also found that the high average interest rates are indicative of high budget deficits which have a crowding out effect on the private sector. The fiscal and monetary authorities should aim at implementing effective debt management strategies aimed at lowering interest rates, controlling inflation and stimulating private sector investment and Malawi‟s economic growth.