Effects of Macroeconomic Variables on the Stock Market The Case of the Czech Republic.docVIP

Theoretical and Applied Economics Volume XVIII (2011), No. 7(560), pp. 53-64 Effects of Macroeconomic Variables on the Stock Market: The Case of the Czech Republic Yu HSING Southeastern Louisiana University, USA yhsing@ Abstract. Applying the GARCH model, this paper finds that the Czech stock market index is positively associated with real GDP and the German and US stock market indexes, is negatively influenced by the ratio of government borrowing to GDP, the domestic real interest rate, the CZK/USD exchange rate, the expected inflation rate and the euro area government bond yield, and exhibits a quadratic relationship with the ratio of M2 to GDP. It suggests that the Czech stock market index and the M2/GDP ratio have a positive (negative) relationship if the M2/GDP ratio is less (greater) than the critical value of 60.0%. Hence, to promote a robust stock market, the authorities are expected to pursue or maintain economic growth, fiscal discipline, currency appreciation, a relatively low interest rate and expected inflation rate, and the M2/GDP ratio which is below the critical value of 60.0%. Keywords: stock market index; government borrowing; money supply; interest rates; exchange rates; foreign stock markets. JEL Code: E44. REL Code: 11B.  54 Yu Hsing 1. Introduction Many countries have experienced declining asset values including stock prices during the recent global financial crisis. The Czech Republic is no exception. The Prague Stock Exchange Index had dropped 67.5% from 1,936.1 on October 29, 2007 to 628.5 on February 18, 2009, which was worse than the 56.6% decline of the SP 500 index during its recent worst-performing period. Although the index has risen from the trough, as of February 9, 2011, it was still 35.4% below the all time high. The significant decrease in stock prices is expected to affect household consumption spending due to