THE EFFECT OF MACROECONOMIC VARIABLES ON

STOCK MARKET PERFORMANCE: A CASE STUDY OF

GHANA

SAMUEL DAGADU

Subject Area: Finance & Economics

Submitted: February 2010

Dissertation submitted to University of Leicester in partial fulfilment of the

requirements for the degree of Master of Science in Finance.
Table of Contents

Acknowledgments
Executive Summary
1.0 Introduction 9
1.1 Macroeconomic factors and Stock market returns 9
1.2 The Role of Governments 10
1.3 The Economy of Ghana 11
1.3.1 The Recent Developments 11
1.3.2 Oil Revenue Expectation 12
1.3.3 Macroeconomic Trends (2000 to 2009) 13
1.3.4 Economic Policies 17
1.3.5 Policy Implementation Experience 18
1.4 The Ghana Stock Exchange 19
1.5 Other Institutions of Importance: The Bank of Ghana 21
1.6 Research Questions 22
1.7 Interest in Research 23
1.8 Structure of Dissertation 24
2.0 Literature Review 25
2.1 Macroeconomic factors that affect Stock Market Returns 25
2.2 Models used to establish relationship between

macroeconomic factors and stock returns 27

2.3 Previous research on Ghana Stock Exchange 29
2.4 Theoretical considerations 30
2.4.1 Interest rates 30

2.4.2 Inflation 31
2.4.3 Fiscal deficits/surpluses 31
2.4.4 Exchange rates 32
2.4.5 Gross Domestic Product (GDP) 33

2
 2.4.6 The Role of Government 35

3.0 Methodology 37
3.1 Data Collection 37
3.2 Variable selection 37
3.3 Model specification 39
3.4 Tests conducted 40
3.4.1 Visual Inspection 40
3.4.2 Unit Roots Tests 40
3.4.3 Co integration Tests 41
3.4.4 Vector Error Correction 42
3.4.5 Granger Causality Tests 42
3.5 Data description 45
3.6 Regression 45
3.7.0 Hypothesis 45

3.7.1 Interest rates 46

3.7.2 Inflation 47
3.7.3 Exchange rate 48
3.7.4 Fiscal deficits/surpluses 48
3.7.5 Gross Domestic Product 48
4.0 Data Analysis 49
4.1 Unit Roots Test 49
4.2 Co-integration 50
4.3 Vector Error Correction 53
4.4 Granger Causality 54
5.0 Research Findings 55
6.0 Conclusion 58
7.0 Recommendation 61
8.0 Reflection 62

3
9.0 References 65

10.0 Appendices 70-103

ACKNOWLEDGEMENTS

I would like to thank Dr. Tomasz Wisniewski of University of Leicester, for his
guidance and advice on topic selection. I also thank Dr. Tse, University of
Leicester, for his advice, guidance and support from the proposal stage through
to final submission.

My appreciation also goes to my employer, Social Security and National

Insurance Trust for sponsoring my studies, to Mr. Kwasi Boaten - Former
Director General and Sheila Sampson, Training Manager, for their interest in my
studies.

My appreciation and thanks goes to my Superiors, Colleagues and Subordinates

for their support during the period of my studies.

I thank Dr. E. E. Y Dagadu for his support and encouragement throughout my

career development and for buying the econometrics software used for the
analysis. I finally wish to thank my immediate family Bridget, Teddy, Jeffrey,
Jennifer, Harold and Philip for their support, patience and understanding during
the period of my studies. It would have been impossible to complete my
dissertation without their involvement. I owe a debt of gratitude to Mr. Simon
Dewotor and his family for mentoring me and showing me the path to success.

4
Executive Summary

This study examines the long and short run relationships between
macroeconomic variables and stock market returns in general using Ghana
Stock Exchange Index as a special case, to find answers to the following
questions: What macroeconomic factors drive the performance of Ghana Stock
Index? How does GDP, Fiscal balance, Inflation, Interest rates and Exchange
rates impact the Ghana Stock Index (GSI)? The macroeconomic variables used
for this study are Gross Domestic Product (GDP), Fiscal balance
(deficit/surpluses), Inflation, Interest rates and Exchange rates.

Finding answers to these questions will help add to existing knowledge about the
underlying causes of price movements of the Ghana Stock Exchange and how
these variables can be useful in predicting the performance of the Ghana Stock
Exchange.

This study was undertaken in partial fulfilment of the requirements for the award
of degree of Master of Science in Finance, University of Leicester.

There is no economic theory that explains the linkage between macroeconomic

variables and stock market performance in one direction, but there are several
macroeconomic factors that have been identified as having impact on stock
market performance. This study used the Dividend Discount Model to select the
variables considered in the study.

5
Cointegration, Error Correction and Granger causality techniques were used to
establish relationships. The long term relationships were analysed and
established by Johansen and Juselius Multivariate Co integration Approach.
Short term relationships were analysed and established through Vector Error
Correction models and Granger Causality tests.

Monthly time series data from January 1991 to December 2008 were used. Data
on Fiscal balance, Inflation, 91 day Treasury bill rates and Exchange rates
movements were obtained from the Bank of Ghana and stock Index movements
were obtained from the Ghana Stock Exchange.

Empirical findings revealed that macroeconomic variables considered are

cointegrated and have statistically significant coefficients that indicate the
existence of long term relationships. The strength of relationship in the short run
is however weak indicating the variables do not have short term relationship. The
results indicate that the Ghana Stock Market has significant positive long run
relationship with GDP and Inflation but negative long run relationship with fiscal
deficit, interest rates and exchange rates. These results are consistent with
current theoretical arguments regarding these relationships. The results are in
line with anticipated relationships between the variables, with the exception of
Inflation, which shows a positive instead of negative relationship.

The policy relevance of this study is significant now and into the future because
the economic policy of Ghana is geared towards growth and stability. The
Country is expecting the production and export of crude oil. GDP is projected to
grow from 5% in 2010 to 24.2 % in 20111. The commencement of oil production
will create serious macroeconomic imbalance which needs to be managed
carefully to ensure sustainable growth and stability. Moreover, individuals,
Pension Funds and Institutional Investors invest on the Stock market to ensure a
future stream of income. Any erosion of capital in the market due to

1
IMF Country Report No.9/256, August 2009

6
macroeconomic imbalances can have dire consequences for all market
participants. This study will be useful in formulating both fiscal and monetary
policies.

Other studies on the Ghana Stock Exchange reported on the impact of inflation,
interest rates, foreign direct investments and exchange rates. No study
considered the effect of GDP and Fiscal imbalances on the Ghanaian Stock
Index. This paper is therefore adding to the body of knowledge on the
relationship between these macroeconomic variables and stock market returns in
Ghana.

The lag length used for the error correction in this study may be a limitation and
might have accounted for the disparity in results when this study is compared
with other studies conducted on the GSI. The slow pace of adjustment suggests
that the macroeconomic factors examined in this study are not exhaustive. There
may be other significant factors which were not considered in this study. Another
limitation is the lack of monthly data for some of the variables. This may be a
contributory factor in the lag length required for the variables to relate to each.

The Government of Ghana is concerned about stability and growth. Greater

stability can be achieved if the Government of Ghana establishes the following
through the Bank of Ghana and the Ministry of Finance. Stable monetary growth
to match the future growth potential of the economy; Manage money supply with
the hope of maintaining prices; Maintain fiscal deficit or surpluses during periods
of recession and periods of expansion respectively; Automatic stabilizers like
unemployment benefits during periods of low economic activities, high corporate
taxes during booms and low corporate taxes during recession, and wider
coverage and progressive personal income tax regimes. The use of Oil revenue
should also be regulated to avoid negative impact on macroeconomic variables.

7
This study has contributed to existing knowledge on the grounds that there is a
lag effect of changes in macroeconomic factors on the Ghanaian Economy in
general and the Stock Exchange in particular. The transmission mechanism of
policy needs further study to identify reasons for the lag and what can be done to
correct it. For example, the current debate on radio and in the print media is for
the Government to compel Banks to reduce their lending rates in line with
reduction in inflation, prime rates and general improvement in other
macroeconomic factors.

8
1.0 Introduction

The Ghana Stock Exchange experienced a highly volatile performance since it

was established in 1990. It was pronounced the best performing stock exchange
in the World in 2004. It performed above 100% in the following years 1993, 1994,
2003 and performed below 0% (zero) in the following years 1990, 1991, 1992,
1999, 2005 and 2009. The causes of these fluctuations in performance can be
attributed to the changes in macroeconomic factors from theoretical and
empirical point of view but not by merely looking at the movement of
macroeconomic variables. The GSE performance is measured by GSE All-
Share- Index, which is a market value weighted index.

1.1 Macroeconomic factors and Stock market returns

Macroeconomic variables have significant effect on stock price movement and

returns but the basis of the causal relationship between macroeconomic
variables and stock prices is not known with certainty as indicated by Flannery
and Protopapadakis (2002). Efficient market hypothesis attributes movement of
stock prices to new information that affect the expected discount rates or future
income. An efficient market, for example, incorporates all current market
information in stock prices. Any new information is captured instantaneously to
reflect all available information. Studies by Fama and Schwert (1977), and Jaffe
and Mandelker (1976) suggest that new information on macroeconomic factors
have an impact on stock prices. This affirms the belief that macroeconomic
variables influence stock returns and thus proposes that stock markets are not

9
efficient. Empirical evidence suggests that stock returns respond to monetary
news but there is no theory on the relationship of stock returns with
macroeconomic variables in one direction, even though stock prices are known
to react to market forces. Uncertainty remained about relationships between
macroeconomic variables and stock performance because of varying economic
conditions of nations, different data set and different testing methods used to
establish these relationships. Economic factors that impact on changing
investment opportunities; the pricing polices; and factors which affect dividends
theoretically, impact pricing and performance of stock exchanges. Predictability
of stock market returns using macroeconomic factors suggests that markets are
not efficient. As indicated by Fama (1991), stock prices reflect expectations of
earnings, dividends, interest rates and future economic activity. If stock prices
reflect the underlying fundamentals, then we can say that there is a causal
relationship between macroeconomic variables and stock prices.

Participants in the stock market anticipate real returns from the stock market so
stock prices will move directly with inflation. Investors directly compare earning
yield on stocks with treasury yields and move funds from one market to the other,
an inverse relationship between stock returns and interest rates is expected.
Fiscal deficits increase Government borrowing which increases interest rates,
which crowd out private individuals and businesses, denying listed companies of
much needed capital resulting in low returns.

1.2 Role of Governments

Twerefou and Nimo (2005) reported that businesses factored into their
operations Government macroeconomic targets for the year. “This invariably
feeds into the determination of stock prices of listed companies”. Twerefou and
Nimo (2005:169). Government’s fiscal and monetary policies have significant
effect on the economy and therefore the capital market. Fiscal policy is aimed at
consumer demand in an effort to manage economic growth. Tax cuts encourage

10
demand and for that matter spending. Tax increases discourage spending and
slow down the economy.

Government’s debt financing causes interest rates to rise and this directly causes
Inflation and depreciation of the local currency. Depreciation results in capital
flights. Investors who do not have confidence in the economy divert resources
from the long term investments to short term treasury bills and consumables or
real estate. Listed Companies are starved of needed resources to finance viable
projects, since they cannot borrow at the prevailing high interest rates, they
become less competitive and their profit levels fall leading to a fall in returns.

The Government of Ghana has a key role to play in ensuring a sound capital
market through macroeconomic measures such as the fiscal environment-
taxation; legal, regulatory and institutional infrastructure, as well as monetary
policies.

Other factors like oil price hikes, change of Governments, international financial
and economic development/crises also have impact on the economy but these
factors were not considered in this study.

1.3 The Economy of Ghana

1.3.1 The Recent Developments

Ghana went through a keenly contested democratic election in December 2008.

The National Democratic Party took over from the New Patriotic Party, which was
in Government for the past eight (8) years, in January 2009. The new
Government adopted a program of macroeconomic stabilization and growth
through reforms in joint partnership and support with the International Monetary
Fund (IMF).

11
The real GDP growth somewhat consistently increased from 3.7% in 2000 to
7.3% in 2008 on the back drop of significant debt relief and strong commodity
prices which gave some fiscal relief to the country in its developmental efforts,
leading to higher output, declining Inflation, and poverty reduction. The improved
macroeconomic environment enabled Ghana to raise US$750 million in
Eurobonds in October 2007 for infrastructural development in the energy sector
in particular.

Important institutional reforms have been undertaken in the financial sector to

safeguard the stability of the financial system but the nation suffered a severe
energy crisis in 2006-2007 as a result of prolonged drought, which lead to near
shutdown of Akosombo Hydro Electric generating plant. This resulted in a shift in
over dependence on hydro power to thermal power at the time of rising crude oil
prices creating macroeconomic pressure on the economy. The global food and
fuel price increases of 2007-2008 hit Ghana very hard. The government
implemented some social mitigation policies which dampened the effects of the
global food crises.

1.3.2 Oil Revenue Expectation

Ghana discovered crude oil along Cape Three Points in fields named the Jubilee
fields. The dominant players are Tullow Oil Plc and Kosmos Energy Plc
Companies. The Ghana National Petroleum Company (GNPC) is also in
collaboration with some Chinese and other oil exploration companies that are
prospecting for oil and gas in five sedimentary basins including inland Voltaian,
offshore Tano and Saltpond basins. It is expected that drilling in commercial
quantities from the Jubilee fields will commence by the last quarter of 2010. Daily
production is expected to be 120,000 barrels until the end of 2012 when the
expected production target is 250,000 barrels per day. The Government of
Ghana is making efforts to create policies and frameworks that will ensure
maximum gains from the oil industry. Particular concerns are how much to save,

12
how much to spend on what, in order to insulate the economy against fiscal
fluctuations, and to protect the economy against exchange rate appreciation.
Other concerns are environmental protection, technological transfers and the
avoidance of the “Dutch disease”. The projected direct annual oil revenue is 7%
of 2008 GDP and about 26% of 2008 domestic revenue. IMF projects 4% to 5%
of annual revenue as indicated by ISSER Report (2008). This is indeed a
substantial injection. It however, excludes revenue from Gas, which is currently
controlled domestically, and downstream industries that will spring up as a result
of the oil Industry.

1.3.3 Macroeconomic Trends (2000-2009)

Ghana experienced macroeconomic instability for many years in the past. This
affected growth of the economy. The Country achieved significant gains in the
macroeconomic and social sectors from 2000 to 2005. The past four (4) years
however experienced imbalances, caused by the energy crises of 2006-2007 and
external shocks resulting from rising food and oil prices. This was compounded
by the 2008 general elections because of increased direct and indirect election
related expenses and energy related subsidies, higher wages and salaries
among others. All these culminated in raising fiscal deficits from 7.81% of GDP in
2006 to 11.48% in 2008 and 10.7% in 2009. The global financial crises
contributed to balance of payment pressures in the face of reducing private
remittances and outflow of portfolio investment proceeds.

The exchange rate plummeted from mid 2008 to June 2009. The rate of
depreciation slowed down because of injection of foreign currency into the
economy by IMF. The cedi weakened against all the major trading currencies like
the Dollar, the Pound Sterling and the Euro.

The Bank of Ghana set a minimum capital requirement of GH¢60 million for
Banks by the end of 2009. Domestic Banks are however required to increase

13
their capital to GH¢25 million by the end of 2010 and then to GH¢60 million by
the end of 2012. The National Pensions Act of 2008 came into effect in January
2010; it provided the frame work for a three tier pension system. The first tier is
run by Social Security and National Insurance Trust (SSNIT). The Occupational
Pension Schemes and Private Pension schemes are run by Trustees who
appoint Fund Managers and Custodians. They all operate under the regulatory
regime of a Pensions Authority. The Pension Authority is expected to ensure that
Pension funds are prudently managed. It is expected that there will be an
injection of capital in the system for speculative and investment activities. Table 1
shows the trend in some macroeconomic variables from 1993 to 2009.

Table 1 Trends of Macroeconomic variables & Chart 1

Market Real Fiscal bal 91 day T/Bills %Δ GHS/

YEAR Returns% GDP% as % of GDP Interest% Inflation% USD
1993 113.74 5.00 (2.65) 32.00 70.80 (13.13)
1994 124.34 3.30 2.26 28.38 32.70 155.11
1995 6.33 4.00 0.95 36.50 20.80 (27.46)
1996 13.82 4.60 (3.16) 41.98 15.70 36.28
1997 41.85 4.20 (8.21) 42.73 13.80 25.21
1998 69.19 4.70 (6.07) 34.28 18.19 12.89
1999 (15.22) 4.40 (6.51) 26.36 4.94 15.21
2000 16.55 3.70 (8.62) 39.10 40.20 104.61
2001 11.42 4.20 (4.36) 40.99 43.49 31.43
2002 45.96 4.50 (6.11) 25.10 9.49 10.62
2003 154.67 5.20 (3.52) 28.80 29.76 9.65
2004 91.33 5.60 (2.77) 17.28 18.18 3.53
2005 (29.85) 5.90 (1.95) 15.43 15.48 0.77
2006 4.97 6.40 (7.81) 10.16 10.96 1.12
2007 31.84 5.70 (8.10) 9.92 10.72 1.98
2008 58.06 7.30 (11.48) 17.79 16.46 13.05
2009 (46.52) 4.7* 10.7* 23.52 19.30 18.11

Source: Bank of Ghana & Ghana Stock Exchange

* Estimates.

14
160

120

80

40

-40
1992 1994 1996 1998 2000 2002 2004 2006 2008

M/Returns% GDP%
Fiscal% Interest%
Inflation% Dollar%

15
 M/Returns% GDP%
160 8

120 7

80 6

40 5

0 4

-40 3
92 94 96 98 00 02 04 06 08 92 94 96 98 00 02 04 06 08

Fiscal% Interest%
4 50

40
0

30
-4
20

-8
10

-12 0
92 94 96 98 00 02 04 06 08 92 94 96 98 00 02 04 06 08

Inflation% Dollar%
80 160

120
60

80
40
40

20
0

0 -40
92 94 96 98 00 02 04 06 08 92 94 96 98 00 02 04 06 08

16
1.3.4 Economic Policy

The Government of Ghana is pursuing economic policies that will ensure the
attainment of macroeconomic stability and growth. The strategy is being
accomplished through fiscal discipline and programs geared towards prudent
public expenditure management, enhanced domestic revenue mobilization,
enforcement of public procurement laws and restructuring of utility companies to
reduce subsidy on the consolidated budget from these utilities. Public sector
reforms are also being under taken to bring on board a single spine salary
structure.

The Government intends to reduce the budget deficit through cuts in low priority
public expenditures in order to reduce total public expenditure in relation to GDP.
Revenue mobilization was to be strengthened to increase revenues in relation to
GDP. Monetary Policy support Government’s fiscal consolidation efforts with
emphasis on price stabilization and growth as well as exchange rate expectation.
This is done through inflation targeting which is a framework by which policies
are guided by the expected path of future inflation relative to already planned and
announced inflation target.

The Ghana Poverty Reduction Strategy (GPRS II) has at its base the provision of
a “life line” scheme to mitigate the risks non income earners or low-income
vulnerable groups face. The Livelihood Empowerment Against Poverty (LEAP)
cash transfer program, school feeding and free maternal care programs,
capitation grant and youth in employment programs, provision of free exercise
books and free school uniforms for school pupils in deprived communities are
examples of mitigating factors in place.

17
1.3.5 Policy Implementation Experience

Maintaining fiscal discipline has been and is still a major challenge for all
Governments of Ghana. Ghana has a well thought out fiscal and monetary policy
but the policy transmission mechanism has some challenges largely because of
implementation. Implementation of economic policy is difficult because of lags
between the time policy makers identify the problem and when decisions are
made as well as when the decisions are implemented as against when the full
impact is felt, the impact of unanticipated changes is greater than that of
anticipated changes. Inflation targeting for instance is based on expected future
inflation. This may suffer from recognition lag, which is the time it takes for policy
makers to recognize that an economic change which needs a policy change has
occurred. Inflation for example can assume a downward trend while discount
rates and particularly Bank base rates will either remain stable or be on the
increase as the economy of Ghana experienced in the past and currently.

Implementation time lag is shorter for monetary policy than fiscal policy. The
Monetary Policy Committee of Bank of Ghana meets frequently to determine the
Prime rate on which interest rates and inflation targeting is based, but fiscal
policy needs approval from Parliament. The impact lag is however shorter for
fiscal policy than monetary policy.

Economic policy based on past events creates certain errors depending on

whether the policy is based on adaptive expectation or on rational expectation.
Adaptive expectation yield systematic errors resulting in over or under estimation.
Inflation targeting policy is based on rational expectation, considers the future
and currently available information instead of historical data. Random forecasting
errors are made but the problem is the time lags and whether the policy change
is expected or not. Expected monetary and fiscal policies have little or no impact

18
on the economy as these factors might have been factored in prices or budgets
of companies. Unanticipated monetary policy changes have a greater impact.

1.4 The Ghana Stock Exchange

The Ghana Stock Exchange was established in July 1989 as a company limited
by guarantee under the Companies code 1963. In October 1990, the Exchange
was given recognition as an authorized Stock Exchange under the Stock
Exchange Act of 1971 (Act 384). Trading commenced on the floor on 12th
November 1990. The status of the Company changed from private to public
company limited by guarantee in April 1994. The GSE is governed by a Council
of representatives from licensed dealers, listed companies, banks, insurance
companies, the money market and the general public. The exchange has been
trading daily since mid 2008. . Prior to that, there were three (3) dealing dates
every week. Trading activities are no longer done on the trading floor. A central
securities depository has been established, securities have been dematerialized
and trades are now done and settled electronically from Brokers offices. Dealers
and the Investing public are required to register their shares online to be able to
trade. The listing requirements include capital adequacy, profitability, efficiency of
management, and float of shares and years of operational existence. The GSE
performance is measured by GSE All- Share- Index, which is a market value
weighted index.

The GSE currently has 35 listed companies, one depository share and one
preference share trading on the exchange actively. Two corporate Bonds, HFC
and Standard Chartered Bank (SCB) Medium Term Bonds are also listed on the
exchange. The HFC bonds will mature in March 2012. These bonds are dollar
denominated with coupons priced at 6 months USD Libor +100bp. SCB Bonds
matured in December 2009. The Government of Ghana has three categories of
bonds, trading with terms of two (2) years, three (3) and five (5) years. The
coupon rates range from (12.8%-21%), (12.08%-16%), and (13.67%-15%)

19
respectively. The current yield on the other hand ranges from (12.64% to
17.11%) for 2 year bonds and (14.87% to 17.44%) for three year bonds.

The listed shares are categorized into Manufacturing, Financial, Mining and Gas
& Oil sub-sectors. The Bank of Ghana and Securities Exchange Commission are
the regulators.

The Ghana Stock Exchange achieved recognition in the global investment arena.
In 2003 it achieved performance of 154.67% and was recognized as the best
performing market in 2004. The remarkable performance was attributed to
economic performance resulting from stable and good macroeconomic factors
during the period leading to investor interest on the exchange. In 2008, Ghana
Stock Exchange was adjudged one of the best during the period of financial
meltdown of advanced markets. The remarkable performance was attributable to
economic performance resulting from stable and strong macroeconomic factors.
The feat of 2008 was to be followed by over 46% negative performance in 2009,
the lowest in Africa. This poor performance was also attributed to poor
macroeconomic factors by Market Analyst, a critical look at the performance
figures suggests some lag of the effect of Macroeconomic factors on market
performance. The good performance of the economy in 2005 to 2006/7 impacted
the market in 2008. The poor performances in 2007 and 2008 impacted the
market in 2009.

It is difficult to say whether the Ghana Stock Exchange is efficient or not. It is

difficult to depend on past price movement to make gains but the same cannot
be said about the release of information. Some Companies announce good
returns and prospects but nothing happens to their prices. This study does not
consider the efficiency of the exchange.

20
1.5 Institutions of Importance :The Bank of Ghana

The Bank of Ghana (BOG) is an independent body with oversight responsibility

over the monetary policy and strategy of Ghana. The objectives of BOG include:

 Maintenance of the general price levels through implementation of

monetary policy.
 Support the general economic policy of Government and promote
economic growth
 Regulation of the financial sector of the economy

The goals of monetary policy of Ghana include:

 Ensuring high levels of employment
 Economic growth
 Price stability
 Interest rate stability
 Financial Market Stability and
 Stability of the foreign exchange rate.

1.6 Research Questions

This paper does not test for market efficiency, but tries to establish short and
long run relationships between various macroeconomic factors and stock returns
using the Ghana Stock Index for stock market performance. Macroeconomic
instability had negative effect on the Ghana Stock Exchange. It is not clear from
available statistics and earlier studies on the Ghana Stock Exchange what
macroeconomic factors or combinations of factors are responsible for the
performance of the exchange. In 1993 for instance, Inflation rose to 70% when,

21
the Interest rate was 30.95% and the Stock exchange recorded a performance
rate of 116.06%. GDP grew in that year by 4.9%. In 1999, Inflation was as low as
21.3% and the Interest rate was as high as 34.19% but the stock performance
was (15.14) % and GDP grew by 4.4%.

The questions then are:

1: What macroeconomic factors drive the Ghana Stock Exchange?
2: How does GDP, Fiscal balance, Inflation rates, Interest rates and
Exchange rates impact the Ghana Stock Index?

Finding answers to these questions will help add to existing knowledge about
the underlying causes of price movements of the Ghana Stock Index and how
these variables can be used to predict market returns. It will be useful in giving
policy guidelines to ensure stability of the capital market. It will also be a useful
guide for Investors and Financial Analyst in assessing the price of stocks and
their systematic risks with anticipated changes in the macroeconomic factors.

1.7 Interest in Research

This study is useful for Private Investors, Pension Funds, Government and policy
makers because investments in equity have an assumption that corporate cash
flows will grow with the economy, thus expected returns on equities may be
linked to future economic performance. Macroeconomic factors impact both
growth in the corporate sector and economy at large. Studying the relationship
between macroeconomic factors and the stock market will assist in planning and
predictability of both stock market and the economy.

There is an emerging trend by which cohorts of investors lose their entire life time
investment on stock markets or in Unit Trusts and Mutual Fund investments due
to macroeconomic changes. Pensioners who expect lump sum payment from

22
Unit Trusts and other Investment Companies on retirement are shocked when
their entire life time investments are wiped out or drastically reduced mainly
because of the risks associated with stock markets. As indicated by David
Swensen (2000), equity biased asset allocation yield higher returns but it
involves the acceptance of higher risks. It is necessary for Trustees of Pension
Funds and other Fund managers to assess the risks involved at each turn of
macroeconomic variables in order to maintain risk and return profile of their
funds. The Government of Ghana and the Central Bank are concerned about
stability and growth. This study attempts to identify how sustainable stability can
be obtained.

The interest of this study is to identify the possible macroeconomic variables that
impact the stock returns and to examine whether these macroeconomic factors
are the cause of fluctuations in stock market performance. I also want to
recommend appropriate strategies to ensure that macroeconomic and fiscal
policies of Governments do not affect Investors, particularly Pensioners,
considering the fact that Ghana has now introduced defined contribution
schemes which is based on individual equivalence as against risk pooling. This
study was undertaken in fulfilment of the requirements for the award of degree of
Master of Science in Finance, University of Leicester.

1.7 Structure of Dissertation

The remaining chapters of this study are arranged in this order:

Section 2, reviews literature and theory in order to identify the variables of
interest to this study and to examine the results of other studies. Section 3,
introduces the data, describes the data and explains the techniques used to
examine and measure relationship between macroeconomic variables and
movements in stock returns. It considers theoretical and empirical justification for
modeling the Ghana Stock Exchange All Share Index as a proxy using specific
macroeconomic variables, as well as the conceptual framework and

23
methodology. Analysis of Data was done in section 4. Section 5 discusses the
findings and interpretation of results. Section 6 gives a summary. Section 7,
gives the conclusions and section 8 considers recommendations and section 9
gives summary of reflections and experience gathered during the period of the
dissertation. The last sections detailed the references and appendices.

24
2.0 LITERATURE REVIEW

2.1 Macroeconomic factors and Stock Market Returns

According to Fama (1970), a stock market is efficient if current market prices fully
and instantaneously reflect all available information about the macroeconomic
fundamentals. Past information therefore contains no news so should have no
effect on stock prices. Studies by Fama and Schwert (1977), Jaffe and
Mandelker (1976) suggested that macroeconomic factors influence stock returns.
Fama (1981), and Smith and Sims (1993) identified inflation, money supply,
exchange rates as some of the major determinants of stock prices. Chen, Roll
and Ross (1986) established the existence of long term equilibrium between
stock prices and Inflation, Treasury–bill rate, Long term government bonds and
Industrial production. They highlighted the fact that, economic factors affected
expected dividends and discount rates. The ability of firms to generate cash flows
and payout dividends is the basis of the long term equilibrium between stock
returns and macroeconomic factors. Discount rates change with the level of
interest rates, term structure and risk premium, expected dividends may change
due to changes in inflation rate, production, and consumption levels.

Fama (1981), Bodie (1976) and other writers made a strong case that inflation
has a negative relationship with stock performance because high inflation rates
add to uncertainty which reduces business confidence and thus lowers stock
prices. This is in direct contradiction to the claim that stocks are hedge against
long term inflation as indicated by Anari and Kolari (2002). Humpe and Macmillan
reported that deflation has resulted in poor stock market performance of Japan.

Interest rates change the discount rate in the valuation model and so influence
current and future cash flows. Mukhererjee and Naka (1995) hypothesized that

25
changes in both short and long term interest rates will affect nominal risk free
rates and so affect the discount rate. Fama and Schwert (1977) felt the
relationship applies to both current period and for lagged observation of interest
rates. Robert Pardy, (1992) emphasised the role of macroeconomic and fiscal
environment in the development and performance of securities market.

Corporate cash flows are related to a measure of aggregate output such as GDP
or industrial production. Darrat and Mukherjee(1987), Mukherjee and Naka
(1995) indicated that Stock Indexes are positively influenced by growth in GDP.
Based on the fact that cash flows from firms are directly related to economic
growth, Ritter (2004) argued that economic growth does not necessarily increase
cash flow of existing stocks and stockholders. According to Ritter (2004) growth
comes from high personal savings, increased labour force participation and
technological change. If increases in capital and labour go into new corporations,
it does to affect the cash flow of existing corporations. He continues that unless
technological change comes from existing companies with monopoly power, it
does not increase profits. It only increases per capita income of consumers.
Many writers used Industrial production as a proxy of real economic activities.
Fama (1990), Geske and Roll (1983) found positive relationship between
Industrial Production and Stock returns through expected future cash flows.

Some risks are involved in “dollarisation” of an economy as against the fact that
investments are attractive when they are denominated in a stronger currency.
Exchange rate appreciations are associated with higher investment leading to
higher cash flows and higher stock performance. In an export oriented economy ,
as indicated by Mukherjee and Naka (1995) currency depreciations have positive
relationship and impact the stock prices; deprecation of domestic currency leads
to increase in demand of exports and cash flows. Currency appreciation, on the
other hand, reduces competitiveness which results in a negative impact on the
stock market.

26
Some studies considered relationship between the same macroeconomic factors
and stock markets in different Countries. Funke and Matsuda (2006) considered
USA and Germany. Humpe and Macmillan compared US and Japan. They
employed the discount valuation model. They found contrasting results in each
country.

Other studies considered macroeconomic and stock market relationships in

developed Countries like USA, Germany, UK and Japan. Flannery and
Propapadakis (2002) examined developed countries like USA, U.K and Japan,
whilst other writers like Choudhry (2001), Wongbagpo and Sharma (2002)
considered developing Countries.

Poon and Taylor (1991) studied the effect of macroeconomic factors on UK stock
prices and found that macroeconomic variables do not affect stock market prices.

2.2 Models used to establish relationships between macroeconomic

factors and stock returns

Ross (1976) linked macroeconomic variables and stock market returns through
an Arbitrage Pricing Theory (APT) using statistical tools like factor analysis. APT
did not specify the factors but were statistically derived. The factors were
fundamental economic aggregates like GDP, Inflation and Interest rates but
these factors were not stated by APT. Multiple risk factors were used to explain
asset returns. ATP concentrated on individual stock returns. It involves modeling
a short run relationship between macroeconomic variables and stock prices in
terms of first differentials, with the assumption of stationarity of the underlying
data. Relevant studies which used this approach include; Fama (1981), Fama
and French (1989), Schwert (1990) among others.

Chen, Roll and Ross (1986) established the existence of long term equilibrium
using specific macroeconomic variables, from the perspective of efficient market

27
theory and rational expectation and inter-temporal asset pricing theory. The
macroeconomic factors were stated. The macroeconomic factors considered
were Inflation, Treasury–bill rate, Long term government bonds and Industrial
production.

The Discounted Cash flow model was also used to establish relationship
between macroeconomic factors and stock returns. This model links stock prices
to future expected cash flows and the future discount rate of these cash flows. All
macroeconomic factors that influence future expected cash flows and discount
rates have an influence on the stock price. This model was also used to establish
long run relationships between stock prices and macroeconomic variables.
Campbell and Shiller (1988) established that Price Earning ratio predict stock
returns over long period of time. They used earnings and expected dividends to
establish the relationship between these factors and stock prices. The limitation
of this approach is that there is no theoretical basis for selection of the variables.

Jiranyakul (2008) used Present Value Model on the Thailand Stock market from
April 1975 to December 2007 to evaluate whether the current market price of
each stock deviates from its intrinsic value (present value of stock’s cash flows),
from fundamental analysis. He concluded that there are other economic
fundamentals other than dividends that cause stock price movements.

Engel and Granger (1987), Granger (1986), Hendry (1986), Johansen and
Juselius (1990), proposed the use of cointegration techniques and error
correction models to establish long run and short run equilibrium between
macroeconomic variables and stock market returns. Time series variables are
cointegrated if they are integrated by the same order and a linear combination of
all the variables is stationary. Linear combination of variables suggests the
existence of long term relationship between the variables. The co-movement of
the variables can be ascertained through error correction processes to establish
short-term equilibrium. Cointegration and error correction models have been

28
used extensively to establish both long run and short term relationship between
stock prices and macroeconomic variables in both developed and developing
countries. This approach has become the preferred method of examining the
relationship between stock returns and macroeconomic variables as indicated by
Maysami, Howe and Hamzah (2004) and Utku Utkulu(). This approach was used
by many writers including Mukherjee and Naka (1995), Maysami (2002) among
others. The number of lags used in these models, particularly the error correction
model, has a great impact on the results.

2.3 Previous Research on Ghana Stock Exchange

Twerefou and Nimo (2005) investigated the impact of asset pricing of the various
sectors of the Ghana Stock Exchange for the period January 1997 to December
2002 using Arbitrage Pricing Theory. They concluded that inflation, short term
interest rates and term structure of interest rates are macroeconomic factors
affecting asset pricing in Ghana.

Adam, Anokye and Tweneboah, (2008), examined long and short run
relationship between interest rate, inflation rate, net foreign direct investment,
and exchange rate and the Ghana stock market during the period January 1991
to December 2006, using cointegration and error correction models. They
concluded that there is long run relationship between stock prices and the
macroeconomic factors examined. They found out that there is a positive
relationship between inflation and share prices.

Kyereboah-Coleman and Agyire-Tettey (2008) used quarterly time series data of

the following macroeconomic factors: Inflation, real exchange rates, Interest
rates, and lending rates to examine the effect of these macroeconomic factors on
the performance of the Ghana Stock Exchange. They concluded that lending
rates have an adverse effect on stock performance and Inflation had a lagged

29
effect on stock performance. They were certain of the fact that depreciation
favors investors.

Frimpong (2009) used the cointegration model to establish long term relationship
between exchange rates, the consumer price index, money supply, interest rates
and stock returns of the Ghana Stock Exchange. He concluded that exchange
rates have positive impact on the exchange while other variables have negative
impact.

These findings do not confirm each other mainly because of the lag period under
consideration. Frimpong considered a lag period of nine (9) for cointegration
analysis and lag of 3 for error correction. This study considers a lag period 10 to
15 for both cointegration and error correction.

2.4 Theoretical considerations

2.4.1 Interest rates

Interest rates generally move in opposite direction with share prices. A fall in
interest rates on money markets makes them less attractive in terms of returns.
Investors generally react by transferring their investment to the stock market.
This results in increase in demand for shares, this may lead to increases in
prices. If interest rates increase on the other hand, investors may channel their
current investments to the money markets thereby staving the stock exchange of
the needed new investments. Trading activities therefore reduce as the market
becomes bearish, as there are more shares on sale than buyers want, leading to
fall in prices.

30
Theoretically, Interest rates are not very significant in the determination of firms’
investment decisions because most firms base their investment decisions on the
profit expectation of investments. Investments, with returns exceeding costs
(positive NPV) will be undertaken. Fluctuation in interest rates will lead to lower
real returns, which will eventually prevent investment in some projects, resulting
in reduced flow of investments. Most firms however, do not borrow to finance
investments. They use internal funds or issue new shares.

2.4.2 Inflation

In theory, stocks should be inflation neutral. This is based on the assumption that
companies can pass on one-for-costs. Secondly, the required rates Investors
used to discount cash flows do not rise when inflation rises. Moreover it is
assumed that inflation does not have long term impact of growth. There is a
theory to support the fact that Inflation is a hedge against long term inflation as
indicated by Anari and Kolari (2002), because it represents claims against real
assets and so stock returns should be positively related to expected inflation.
Another theory supports the idea that Inflation negatively impact on stock prices.
This is based on Fishers’ theory of interest which indicated that nominal interest
rates may be decomposed into real rates and expected inflation. The argument
here is that expected real returns are determined by real factors which are not
related to inflation.

2.4.3 Fiscal deficits/Surpluses

The main source of revenue for Governments is taxation. Personal and corporate
taxes move in the same direction as growth of profits in the corporate sector.
Fluctuations in government revenues are related to market movement.
Governments do not limit their expenditure to revenue they spend more
normally.. Deficits arise when expenditure is more than revenue and surpluses
result when revenue is more than expenditure. Government treasuries borrow on

31
the open market to finance short fall in revenue. These debts are repaid in
periods of surpluses. Government may also print more currency notes but this
causes inflation. It can be said in general that, stock market returns have positive
relation with Fiscal surpluses and negative relation with Fiscal deficits.

2.4.4 Exchange rates

An exchange rate is the ratio of how many units of one currency you can buy per
unit of another currency. Unanticipated currency movements results in risk of
changes in the value of assets and liabilities of a firm. It impacts on sales, prices
and profits of importers and exporters. It also reduces competitiveness. Purely
domestic firms which are not involved in imports and exports may also suffer
from exchange rate risk when they compete with foreign companies in their home
markets. The three main types of foreign exchange risk exposures are
translation, transaction and operating exposure.

There are three factors which cause the currency of a Country to appreciate or
depreciate. These are:
 Differences in income growth: Nations with high income growth will
demand more imported goods all other things being equal resulting in
demand for more foreign currency leading to appreciation in foreign
currencies relative to domestic currency.
 Differences in inflation rates: Consumers in a country with higher inflation
rate will demand more imported (cheaper) goods from other Countries
leading to appreciation of foreign currencies and depreciation of local
currency.
 Differences in real interest rates: Differences in real interest rates results
in a movement of capital from countries with lower real interest rates to
countries with higher interest rates.

32
2.4.5 Gross Domestic Product (GDP)

Economic factors that impact on changing investment opportunities include

macroeconomic factors which are measured by Gross Domestic Product (GDP),
a measure of economic performance. GDP does not include purchase and sale
of stocks since these are not production of goods. GDP measures both output
and income. If output increases per person this translates into higher standard of
living. GDP does not measure homemaker services and other non market
production nor underground economy e.g. Illegal activities and tax evasion.

Economic growth is the increase in value of goods and services

produced in an economy. It results from saving and use of capital, increase in
work force and from technological changes. It is measured by the percentage
increase in the real Gross Domestic Product (GDP). GDP is the total market
value of all domestically produced final goods and services in a given year. It
includes income earned by foreigners but excludes income earned by citizens
abroad. The Expenditure approach is measured by the summation of the
following.

GDP = C + I + G + X, where

 (C) is household consumption of goods and services.

 ( I ) is expenditure of businesses. It includes capital replacement
and new additions to capital assets, as well as investments in
Inventory.
 (G) is Government consumption and gross investment. It includes
purchases of goods and services by Government and its agencies.
It excludes transfer payments.
 (X) is net export of goods and services.

33
Current year values are used with a GDP deflator and base year values to derive
real GDP.

Factors that affect aggregate demand (GDP) in an economy include:

 Real Wealth: An increase in consumers’ real wealth will increase

aggregate demand because of an increase in consumption. A fall in
real wealth will lead to fall in consumption and for that matter GDP
decreases.
 Real Interest Rates: An increase in real interest rates will lead to a
decrease in consumer expenditure and business investment
resulting in a decrease in aggregate demand. A decrease in real
interest rate on the other hand increases aggregate demand
through reduction in finance costs for both businesses and
consumers.
 Inflation expectation: An expectation of future increase in inflation
will increase aggregate demand whilst a decrease in the expected
rate of inflation will reduce current purchases and aggregate
demand.
 Exchange rate fluctuations: Currency appreciation leads to an
increase in the value of the domestic currency (GH¢) compared to
other currencies. This makes imports less expensive leading to an
increase. Exports on the other hand become more expensive to
foreign consumers leading to a fall. Since Ghana imports more than
it exports on aggregate basis, Net Exports (Exports-Imports) will be
negative leading to a fall in aggregate demand. Currency
depreciation will on the other hand increase exports and reduce
imports leading to increase in aggregate demand.
 Economic Expectations: Positive expectation about the future
prospects of the economy increases aggregate demand resulting

34
 from increase business investment in capital in anticipation of
increased future sales.
 Higher productivity from both capital and labour will increase
aggregate demand.
 Investment in research and development as well as Innovations
and technological development will increase aggregate demand.
 The rate of local capital accumulation also affects aggregate
demand.
 Government policies in encouraging education, technological
development, trade promotion, low taxes and high savings rates.

An economy with increasing GDP all other things being equal will have rising
Income. This will lead to an improvement in the disposable incomes of
individuals. Demand for shares which is related to the level of disposable income
will increase leading investors to buy more shares; the higher the demand for
shares and higher the share prices to move up. When the economy is sluggish,
the level of income and hence disposable income is affected negatively. There is
no increase in production, employment is low leading to loss of jobs and reduced
disposable income for most workers resulting in investors cutting back on their
investments in shares. The resulting fall in demand for shares leads to a fall in
share prices.

2.5 The Role Governments

Government can improve economic growth by adopting pragmatic policies that

encourage growth by constantly monitoring the business cycle (contraction,
recession, expansion and business peak). Governments can create an enabling
environment by providing infrastructure (educational, technological, financial,
physical, environmental, and social) as well as tax regimes and general
confidence in the business environment.

35
Governments as agents of development and growth can also use their
consumption and Investment to facilitate growth. Replacement, new and capacity
enhancement investment in facilities that boost business production will provide
good investment climate. Government’s investment in infrastructure is a
necessary tool in boosting business confidence.

Governments wishing to promote economic growth may endeavour to maintain

incremental macroeconomic stability. They should avoid budget deficits and
excessive surpluses. Time lags in recognition, implementation and impact of
policy should also be monitored and controlled to ensure policy interventions
yield desired results.

36
3:0 Methodology

This section provides an overview of the data collection, variable selection,

model specification and tests conducted. There exists no theoretical framework
for selection of macroeconomic variables that affect stock market performance.
Economic theory suggests that stock market prices should reflect expectation
about future corporate cash flows which generally reflect the level of economic
activities relate to aggregate output such as Industrial Production or GDP. If
stock prices reflect the underlying fundamentals, then the stock prices could be
used as indicators for future economic activities. It can be said therefore that the
relationship between stock prices and macroeconomic variables are useful in
formulation of macroeconomic policies.

3.1 Data Collection

Monthly time series data from January 1991 to December 2008 was used in the
model. Data on Fiscal balance, Inflation, 91 day Treasury bill rates and Exchange
rates movements were obtained from the Bank of Ghana. Stock Index
movements were obtained from the Ghana Stock Exchange. The Ghana Stock
Exchange, All Share Index (GSI) is a composite index which measures price
movements of all equities listed on the exchange. The index is based on the low
and high prices within the month/year as against beginning and closing figures.

3.2 Variable Selection

There is no economic theory that explains the linkage between macroeconomic

factors and stock market performance but there are several macroeconomic
factors that have been identified as having impact on stock prices. This study
uses dividend discount model to select the variables considered in the study.

37
Returns on stocks market are two fold. Capital Gains (price changes) and
Dividend yield. Capital gains are the percentage increase or decrease in the
price of an investment and includes gains or losses due to changes in exchange
rates. Capital gains are computed by (P1/P0-1)*100. Dividend yield is stated as a
percentage of price (D1/P0 )*100. Where P1 is current period prices and P0 is last
period prices and D1 is current period dividend per share. This study considers
only capital gains computed on the basis of high and low price movements in the
month/year. Dividend yield is excluded because of lack of data.

Changes in the earning capacity of a firm depend on general economic and

market conditions. A change in individual stock returns depends on changes in
rates of return for the entire stock market and the stock’s Industry. This requires
examination of Macroeconomic, Industry and Individual stock performance, but
this study is limited to the impact of macroeconomic factors on the entire stock
market irrespective industry differences.

Gordon’s Dividend Growth model assumes constant growth. The value of a stock
is derived from

P0 = D0(1+g) or D1
. k-g k-g

where, g is constant growth in dividend, k is the required rate of return and D1 is

expected dividend, which is a product of current dividend and growth rate.

It is clear from the equation above that price depends on market discount rates
and expected stream of dividend payments and growth factors.

Expected inflation is built up in prices and projections so it may not affect stock
prices, but unanticipated inflation may directly influence stock prices through
changes in price level and through increases in discount rates. An increase in

38
discount rates reduces, the present value of corporate cash flows. The impact of
inflation on discount rates and price levels makes it imperative for its inclusion in
model.

Money supply directly impact on interest rates. Interest rates influence

investment decision on holding non interest bearing securities or interest bearing
securities. At high interest rates, Investors may sell Equities to invest in Treasury
Instruments. Interest rates change the discount rate in the valuation model and
influences current and future cash flows. Long term bond yield will have been
ideal for this studies, due to lack of data availability we use the 91 day treasury
bills, which is more sensitive to the market at all times than the one year rate in
an inverted term structure of interest rates which currently exists in Ghana.

The Ghanaian economy depends largely on loans, donor support and

remittances from citizens of Ghana resident abroad. The shares of AGC and
Golden Resources are traded on foreign stock markets. Prices of houses, cars
and other consumer items are quoted in dollars. Fluctuations in the dollar rate,
which represent all foreign currencies, have significant impact on the economy
therefore its inclusion in the model.

3.3 Model Specification

The GSI is the dependent variable of the regression equation. It represents the
performance indicator of the Ghana Stock Exchange. Fiscal Deficits/Surpluses
captures the income and expenditure position of the economy; Interest rates are
approximated by 91 day Treasury bills; Inflation rate and Exchange rates are the
other independent variables.

The model is:

39
 GSI = β0 + β1FD + β2INTrate + β3INFrate + β4EXrate + β5GDP + et Eq1

where GSI is the Ghana Stock Index, FD is Fiscal position, INTrate is interest
rate, INFrate is inflation rate, EXrate is the exchange rate and GDP is gross
domestic product, β0 - β5 are coefficients of variables and et is the error term,
representing others factors not considered in the model e.g. Oil price hike and
change in Government.

To examine causal relationship of the variables we specify the following

multivariate model:

U = (GSI, GDP, Fiscal, Interest, Inflation, Exchange)

where GSI is the Ghana Stock Index, GDP is gross domestic product.
Fiscal is the fiscal position of Income and Expenditures, Interest is interest rate,
Inflation is inflation rate, and Exchange is the exchange rate.

3.4 .0 Tests conducted

3.4.1 Visual Inspection:

Visual inspection of the time series data was observed and comments made on
movement in the variables.

3.4.2 Unit roots Tests

Standard inference procedures do not apply when regressions contain integrated

dependent variables or integrated regressors so it is necessary to ascertain
whether a series is stationary or not before using regressors since the eventual
results may be spurious. A series is stationery if the mean and auto-covariance
are not time dependent. If the first differences are stationery, the series is said to

40
be integrated by the order 1(d) where d is the order of integration. The order of
integration defines the number of unit roots contained in the series or the number
of differentiations it takes to make the series stationary. Stationarity ensures that
the variables are stationary and that shocks are temporary and will revert to long
term mean after the effect of the shock. It is useful in deriving meaningful
statistics such as means, variances and correlations. Unit roots tests was applied
using Augmented Dickey Fuller (ADF) test with automatic maximum lag of 14
and Schwarz Information criterion to ascertain the order of integration of each
variable to ensure stationarity of the variables. The automatic lag period 14
measures the correlation between observation 1 and 15, observation 2 and 16 in
that order. The existence of unit root means the data set is non-stationary. Non-
stationary time series data tend to be auto correlated whilst stationary time series
data tend to be random.

The ADF calculates a test statistics which if greater than the Dickey – Fuller
critical values, the null hypothesis can be rejected and conclusions drawn that
the data had unit roots and so they are stationary. The critical values used for
this study is -2.875 at 5%. We first test the original data. It was found to be non
stationary so we make the data set stationary by taking the first difference
transformation, in order to eliminate the trend relationships in the data.

3.4.3 Cointegration Tests

To establish long term relationships and co-movement among the variables, Co

integration techniques by Johansen and Juselius (1990), Johansen (1991)
protocols was used instead of Engle and Granger (1987) because the analytical
software EViews is limited to Johansen protocol. The Johansen’s (1991) Vector
Error Correction Model also allows testing for cointegration in a whole series of
equations in one step without requiring normalization of variables unlike the two
step approach of Engel and Granger (1997).

41
If two series are co integrated or have long term relationship, it means there
exists a stationery linear combination of these series and the series are of the
same order. A unit root test for stationarity of the time series data is first
determined before the cointegration test. This test determines the existence of a
unit root test of each series. The series are observed to determine whether they
are stationary or they are integrated of the same order. If two variables are non-
stationary but stationary in first difference, the series can be said to be integrated
of order one. Thus they are I(1) series.

Cointegration tests were performed using Johansen VECM using ordinary least
square regression. There are two tests; the trace statistics which tests the null
hypothesis that there are at most r cointegrating relationships and the eigenvalue
statistic which tests the hypothesis of r cointegrating relationships against the
defined alternative of r+1 cointegrating relationships. An advantage of the
cointegration analysis is that co-movement among the variables can be
examined.

3.4.4 Vector Error Correction

Cointegration was confirmed so Johansen and Juselius (1990) Error Correction

Model was used to establish short run causal relationship between the two
variables. Vector Error Correction model is a system of equations for which, each
variable is a function of its own lag and the lag of other variables in the system.
The variables have an order 1 and are cointegrated. The F tests of the
explanatory variables determined indicate short run relationships.

3.4.5 Granger causality tests

Granger causality tests using bivariate vector autoregressive method was used
for all pairs of the series in the group. It measures the precedence and
information content but does not by itself indicate causality in the more common

42
use of the term. It examines short term causal relationships between the stock
returns and each variable by calculating F statistic of the joint hypothesis. If one
variable does not improve the forecasting ability of the other variable, then the
first variable does not Granger cause the second. If the F statistic is significant,
we can reject the null hypothesis that variable 1 does not Granger cause variable
2.

3.5 Data Description

The data covered a period of eighteen (18) years with two hundred and sixteen
(216) observations on GSE, real GDP, FISCAL, INFLATION, INTEREST and
percentage change in Exchange Rates. GES, real GDP, INFLATION and
INTERST rates are expressed in percentages. Fiscal is the fiscal balance as a
percentage of GDP Table below gives the summary of the data.

Table 2. Summary of Data

GSE GDP FISCAL INFLATION INTEREST EXCHANGE
Mean 43.75667 4.883333 -4.522222 24.08683 28.22486 -1.172062
Median 30.84500 4.650000 -4.580000 18.11500 27.00000 -0.935779
Maximum 154.6700 7.300000 2.260000 70.80000 47.93000 0.181738
Minimum -15.22000 3.300000 -11.48000 0.390368 9.600000 -3.365348
Std. Dev. 47.93129 0.994637 3.658188 16.71154 12.01295 1.126772
Skewness 0.870153 0.657757 0.200122 1.466142 0.119472 -0.526171
Kurtosis 2.699739 2.952106 2.356296 4.630702 1.922574 1.876563

Jarque-Bera 28.06942 15.59582 5.170946 101.3173 10.96147 21.32581

Probability 0.000001 0.000411 0.075360 0.000000 0.004166 0.000023

Sum 9451.440 1054.800 -976.8000 5202.756 6096.570 -253.1654

Sum Sq. Dev. 493942.8 212.7000 2877.203 60044.22 31026.87 272.9673

Observations 216 216 216 216 216 216

The sample period recorded average fiscal deficit of 4.5% and exchange rates
show an average percentage change of 1.17% change. The Ghana Stock
Exchange shows a mean performance rate of 43%. All variables are positively
skewed above normal with the exception of exchange which is negatively
skewed. It indicated that there are outliers which are greater than the mean in all

43
the variables with the exception of exchange which have outliers less than the
mean. All the variables have relatively low Kurtosis. They are all more or less
peaked than a normal distribution which has a Kurtosis of 3 standard deviations.
GDP looks normal whilst GSE, Fiscal, Interest and Exchange are less peaked
than normal distribution. Inflation is more peaked than normal distribution.
Jarque- Bera statistics significantly rejects normal distribution of all the variables
indicating non-normality.

The coefficient of variation (Standard Deviation/Mean) as shown below is used to

examine the volatility of each macroeconomic factor.

GSE GDP FISCAL INFLATION INTEREST EXCHANGE

1.095 0.20 -0.81 0.694 0.425 -0.96

This shows that the Ghana Stock returns are very volatile, recording over 100%.
Exchange rate, and Inflation and Fiscal fluctuations also show wide variability.
GDP and Treasury bill rates are more stable than the other variables.

3.6 Regression

Table 3 Regression
Dependent Variable: GSE
Method: Least Squares
Date: 11/23/09 Time: 10:13
Sample: 1991M01 2008M12
Included observations: 216

Variable Coefficient Std. Error t-Statistic Prob.

GDP 6.408043 1.563947 4.097352 0.0001

FISCAL 1.376725 0.868126 1.585859 0.1143
INTEREST -0.043016 0.226801 -0.189666 0.8498
INFLATION 0.992898 0.199781 4.969923 0.0000
EXCHANGE -2.081595 1.291448 -1.611831 0.1085

R-squared 0.148491 Mean dependent var 43.75667

Adjusted R-squared 0.132349 S.D. dependent var 47.93129
S.E. of regression 44.64693 Akaike info criterion 10.45832
Sum squared resid 420596.5 Schwarz criterion 10.53646

44
Log likelihood -1124.499 Hannan-Quinn criter. 10.48989
Durbin-Watson stat 0.134767

Table 3 shows the results of multiple regressions of all the variables. The results
indicate that less than 15% of movement in the stock market is explained by the
independent variables. This regression is not valid because the variables are
cointegrated. Multiple regression analysis alone is not be able to answer the
research questions since the variables of interest are interdependent and the
analysis require a test of the stationarity of the data to establish the causality of
price movement and dependencies of the variables. The original time series data
was used to conduct an Ordinary Least Squares regression between two
variables at a time under the model:

Yt = a + Bxt + ut Eq2

Where, ut is the estimated residuals on the long run equilibrium to establish the
existence of unit roots.

3.7.0 Hypothesis

The following hypotheses were made about the relationships between short and
long term interest rates, inflation, exchange rates, fiscal balances and GDP.

3.7.1 Interest rates

Dividend discount valuation model is very elaborate on the impact of interest

rates on the price of stock. In Gordon’s constant dividend model,

45
 P =D1/ (k-g) ------------------------ equation 1,

Where P is the stock price, D1 is dividend after first year, g is the constant growth
in dividend, and k is required rate of return.

Changes in both short and long term interest rates affect discount rates used by
investors to evaluate projects. From the equation above, if k is greater than g,
there is a negative relationship between k and P. If k increases, P reduces. The
first hypothesis is that:

 There is a negative relationship between interest rates and stock prices.

Intuitively, interest rates influence corporate profits, and therefore expected future
dividend payments. The lower the interest rates the more profit available for
reinvestment or for distribution, the more future expectation and the more willing
investors are to buy the shares leading to increase in prices. Investors using
borrowed funds will enjoy reduction in interest rates because of its impact on cost
of borrowing. Reduction in interest rates will increase demand for shares since
investors will require lower rate of returns to buy shares. High interest rates
encourages investors to make quick money by buying treasury bills at the
expense of stocks this results in reduced demand and eventually drive down
prices.

3.7.2 Inflation

The real rate of interest is the nominal rate minus inflation. Both short and long
term inflation will directly result in higher real rates leading to higher discount
rates. From equation 1, the hypothesis stands as above for interest rates that:

46
  There is a negative relationship between inflation and stock prices on
condition that inflationary movements are unanticipated.

High Inflation rates increase the cost of living and divert resources from
investment on the stock market to consumables and real estate among others
whose prices are on the increase in order to preserve capital. This results in low
trading volumes and general lack of liquidity of the stock market. Lack of liquidity
and low demand constrain traders to accept discounts on shares they offer for
sale, this culminates in low prices. Inflation may lead to increase in cash flows
but the increase can not buy the same basket of goods and services because
cash flows will not grow at the same rate. An increase in Inflation directly
increases the nominal risk free rate of interest which raises the discount rate
resulting on negative impact on the price of shares and the general performance
of the Stock Index.

If inflation is expected however, all pricing in the economy will include inflation
expectation, stock market prices are relatively well priced, so one will expect that
inflation will have positive effect on the stock market returns.

3.7.3 Exchange Rates

The Ghanaian economy is import dependent. Trade balances are mostly in

deficit. Depreciation of the currency against the dollar in particular hurts the
economy greatly, as cost of production goes up, corporate profits reduce.
Depreciation of the cedi however favours exporters. Export oriented companies
on the exchange will experienced increase economic activity with depreciation
but since Ghana is import dependent, I hypothesis that:

47
  Depreciation of the Ghanaian currency has negative impact on the stock
exchange and stock prices.

3.7.4 Fiscal Deficits/Surpluses

An increase in budged deficit requires more money to finance the deficit resulting
in increased money supply or open market operation by the Central Bank.
Increased interest rates which come with selling Treasury instruments stave
listed companies of needed capital as returns on treasury instruments become
very lucrative far above the short term returns of the stock market. I hypothesis
that:

 There is a negative/ (positive) relationship between budget deficits/

(surpluses) and stock market returns.

3.7.5 Gross Domestic Product

Gross Domestic Product measures the real economic activities. It is high during
periods of economic growth and low during periods of contraction. I hypothesis
that;

 There is a positive relationship between GDP growth and stock market

returns.

4.0 Data Analysis

4.1 Unit Root Tests

It is necessary to ascertain whether a time series data is stationary or

nonstationary before relying on regression analysis because there is a danger of

48
obtaining regression results from unrelated data from nonstationary series
yielding spurious regression. Unit Roots tests for stationarity were used to
identify the order of integration. The results listed below shows that the
calculated Augmented Dickey – Fuller (ADF) test is greater than the test statistics
so we do not reject the hull hypothesis of nonstationarity, thus all the variables
are nonstationary. We however need to transform the series to stationary. The
lag length used for the ADF test is based on Schwartz information Criterion
(SIC). The indicative lag ranged from zero (0) to twelve (12).

Table 4: Summary of Level 1 ADF Unit Root Test *

Variables Levels t-statistic Lag Length

GSE -2.705 -2.875 0

GDP 0.265 -2.875 12

FISCAL -1.403 -2.875 0

INTEREST -1.619 -2.875 1
INFLATION -2.282 -2.875 1
EXCHANGE 0.045 -2.875 3

* Calculated ADF is greater than 5% critical value so we do not reject the null hypothesis of non stationarity

The original series based on the ADF tests are non stationary so we take the first
difference transformation of the non stationary data and based on ADF test. The
series is now stationary because the calculated ADF is lower than the test
statistic as shown in Table 5. We therefore reject the null hypothesis of
nonstationarity.

Table 5: Summary of Level 2: ADF Unit Root Test **

49
Variables First Difference t-statistic Lag Length

ΔGSE -14.595 -2.875 0

ΔGDP -8.031 -2.875 11

ΔFISCAL -14.594 -2.875 0

ΔINFLATION -10.459 -2.875 0

ΔINTEREST -12.595 -2.875 0

ΔEXCHANGE -12.876 -2.875 2

** Calculated ADF is less than 5% critical value so we reject the null hypothesis of non stationarity.

This shows that an equilibrium relationship has been established to enable us

deduce long run relationships. This implies two or more variables cannot move
independently of each other and data from a linear combination of any two
variables can be stationary despite the fact that those variables may be
individually non stationary, this is however only possible if the variables are
integrated to the same order (order 1) as the trends in both series cancel each
other.

4.2 Cointegration

Methodology of Johansen (1991) was used to test the model to determine the
rank, r and to find the cointegrating relationships in the model. Selection was
made for intercept and “no trend” for the cointegrating equation. It was noted
that the lag length was very relevant in the long term relationship of the variables,
lag length of 2 to 6 for instance yielded no cointegrating equation but lag period
of 10 to 15 showed one cointegrating equation for both Trace and Eigenvalue
tests at 5% significance level, as indicated in Appendix B.

The null hypothesis for the Trace test, is that the number of cointegrating vectors
is less than or equal to 1 against an alternative hypothesis that there are more
than 1 cointegrating vectors. The Maximal Eigenvalue test has the null

50
hypothesis is that there are r cointegrating vectors present against the alternative
that there are (r+1) present.

The normalized cointegrating coefficients for the model is shown below

Yt = (GSEt GDPt, FISCALt INTERESTt INFLATIONt EXCHANGEt) is

β1 = (1.00 - 4.19 + 3.12 + 2.14 - 3.81 + 1.21)

The cointegrating relationship can be re expressed as

GSE = 4.19 GDP - 3.12 FISCAL – 2.14 INTEREST + 3.81 INFLATION – 1.21 EXCHANGE
(3.8) (7.2) (2.9) (1.8) (9.0)

The coefficients are all significant and those of GDP and Inflation are positive
whilst those of Fiscal, Interest and Exchange rates are negative. This indicates
that GDP and Inflation are positively related to the GSE and negatively related to
Fiscal, balances, Interest rates and Exchange.

The existence of cointegration implies significant error correction term, which

also is an indirect test of short run causality. The coefficients are significant. It
indicates co-movement between stock market performance and the
macroeconomic variables of interest in this study. It establishes long run
equilibrium relationship.

The table 7 below shows the normalized co-integration equation and the
adjustment coefficients.

Table 7 Normalized Co-integration equation

1 Cointegrating Equation(s): Log likelihood 2103.563

51
Normalized cointegrating coefficients (standard error in parentheses)
GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 -4.19E-16 3.12E-16 2.14E-16 -3.81E-18 1.21E-14
(3.8E-08) (7.2E-09) (2.9E-09) (1.8E-09) (9.0E-08)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000
(1.6E-09)
D(GDP) -0.002605
(0.00116)
D(FISCAL) 0.003518
(0.00528)
D(INTEREST) -0.002204
(0.01025)
D(INFLATION) -0.037004
(0.02077)
D(EXCHANGE) -3.82E-05
(0.00041)

The movement away from the long term equilibrium is determined by the
adjusting coefficients. This shows insignificant movement with the exception of
Exchange which responds quickly to short term shocks in the opposite direction.
The coefficient of -1.2 compared with adjusting coefficient of 3.8, is possible to
affect the long run equilibrium.

4.3 Vector Error Correction Analysis

Since the variables have an order 1 and are cointegrated, we proceed to

examine the short run causal relationship between the Ghana Stock Index and
the macroeconomic factors of interest, using the Vector Error Correction model,
which is a system of equations for which each variable is a function of its own lag
and the lag of other variables in the system. It is useful for identifying and testing
the short run equilibrium relationship among the variables and to ascertain the
impact of each macroeconomic variable on the stock market returns. The error
correction term and their joint significance are provided by the F statistics.

The F statistics listed in Appendix 3 range from 1.59 to 5.96. This rejects the null
hypothesis that the coefficients of the variables are equal to zero. As shown in

52
the error correction equation in table 9 below: all the variables contribute towards
the error correction process. This indicated short term relationship.

Table 8 Error Correction equation

Error Correction: D(GSE) D(GDP) D(FISCAL) D(INTEREST) D(INFLATION) D(EXCHANGE)

CointEq1 -1.000000 -0.002605 0.003518 -0.002204 -0.037004 -3.82E-05

(1.6E-09) (0.00116) (0.00528) (0.01025) (0.02077) (0.00041)
[-6.2e+08] [-2.23989] [ 0.66682] [-0.21502] [-1.78167] [-0.09390]

The table above shows that Interest and Exchange have coefficients in opposite
direction but all the other variables have error correction coefficients with the right
sign. The speed of adjustment appears to be fastest for Exchange but it not
statistically significant. The other variables are very slow this gives an indication
that it takes a long time for stock market to get back to equilibrium after changes
in macroeconomic variables. This result suggests less effective short term
relationship between the Ghana Stock Market returns and the macroeconomic
variables.

Table 9 Regression of Stationary Data

D(GSE) D(GDP) D(FISCAL) D(INTEREST) D(INFLATION) D(EXCHANGE)

R-squared 1.000000 0.431654 0.355578 0.272909 0.558877 0.584641

Adj. R-squared 1.000000 0.297510 0.203478 0.101298 0.454761 0.486606
Sum sq. resides 5.90E-25 5.832479 119.9482 452.8057 1859.414 0.712664
S.E. equation 6.05E-14 0.190333 0.863145 1.677038 3.398405 0.066532
F-statistic 4.34E+29 3.217848 2.337793 1.590273 5.367835 5.963584
Log likelihood 69.69982 -232.6620 -365.5023 -506.7576 279.9186
Akaike AIC -0.306998 2.716620 4.045023 5.457576 -2.409186
Schwarz SC 0.336174 3.359792 4.688195 6.100748 -1.766014
Mean dependent 0.308450 0.017000 -0.048500 -0.003650 -0.080350 0.005793
S.D. dependent 17.43455 0.227088 0.967131 1.769030 4.602373 0.092855
,
Determinant resid covariance (dof adj.) 1.07E-29
Determinant resid covariance 2.92E-30
Log likelihood 2038.733
Akaike information criterion -17.98733
Schwarz criterion -14.02935

53
 Table 10 shows regression of stationary data. R2 show low to medium
explanatory power of the variables considered.

4.4 Granger Causality

The existence of relationship between macroeconomic factors examined above

does not help in determining the direction of causality. We select a lag length of
fifteen (15) to conduct Granger causality tests to examine the causal
relationships of each variable and the stock market returns using bivariate vector
autoregressive model. F test was used to test for the significance of each
explanatory variable.

From the table above, it can be concluded that:

Fiscal Granger cause GSE and GSE granger cause Fiscal in a bivariate
direction.

Exchange Granger cause GSE but GSE does not Granger cause exchange. It is
unilateral relationship.

GDP Granger cause Exchange but Exchange does not Granger because
Exchange It is a unilateral relationship

Fiscal Granger cause inflation but Inflation does not Granger cause Fiscal. It is a
unilateral relationship

Exchange Granger cause Inflation and Inflation Granger cause Exchange, in a

bivariate relationship.

5.0 Research Findings

54
Results obtained from the analysis of data indicated that macroeconomic factors
considered in this study have unit roots and so multiple regression analysis will
not yield any meaningful results. Cointegration analysis shows that all the
variables of interest have significant coefficients indicating long term relationship.
The speed of correction in the short term is slow; this is confirmed by Granger
causality test. The results indicate that the Ghana Stock exchange has a positive
long run relations ship with GDP and Inflation but negative long term with fiscal,
interest rates and exchange rates.

These results are substantially in line with findings reported in earlier studies of
the GSE. Anthony Kyereboah-Coleman (2008), Kwame Agire-Tettey (2008) and
Frimpong (2009) reported that Treasury Bill rates (Interest) have negative impact
on Ghana Stock Exchange returns. High interest rates will lead to diversion of
investment funds from the exchange to money market. This study indicated that
Inflation has a positive influence on the Ghana Stock Market returns. This
confirms the findings of Anthony Kyereboah-Coleman (2008), but is contrary to
the findings of Kwame Agire-Tettey (2008) and Frimpong (2009). This study also
indicate exchange rates have negative influence on the market which confirms
the findings of Anthony Kyereboah-Coleman (2008), but is contrary to the
findings of Kwame Agire-Tettey (2008) and Frimpong (2009) as in the case of
Inflation. The comparative results are shown in table 12.

Table 12 Comparative results of studies on GSE

Macroeconomic Factor Coleman& Tettey Anokye & Tweneboah Frimpong This Study
GDP N/A N/A N/A +
FISCAL N/A N/A N/A -
INTEREST - - - -
INFLATION - + - +
EXCHANGE + - + -

The differences in findings can be explained firstly by consideration of

expectation theory and the lag period considered by the individual studies.

55
Inflation expectation makes Companies build their expectation in their prices for
both long run and short run this deviated from the theoretical expected position.
This study confirms the fact that the Ghana Stock Exchange does not respond
quickly to changes in macroeconomic factors. Anokye and Tweneboah (2008)
reported that the Exchange responds less to real activity than to monetary
shocks. From their studies, it took five (5) quarters or twenty (20) months for
shocks in Treasury Bills rates to have an impact on the Stock market. The period
range from five (5) quarters to twelve (12) quarters which is essentially medium
to long run. The transmission mechanism of macroeconomic factors need further
studies to understand why changes in macroeconomic factors take a long time to
have an impact on the market.

A weak currency increase the price of imported goods so Companies of a net

importing Country like Ghana will suffer with currency depreciation. Findings
suggest that the stock exchange and the cedi move in the opposite direction,
appreciation in the cedi reduces stock market performance and depreciation of
the cedi strengthens stock market performance.

This analysis emphasis the importance of lag in the implementation of economic

policy based on expectation of economic activity. The lags include recognition,
implementation and impact. The impact lag is shorter for fiscal policy than
monetary policy. Unanticipated changes have greater impact than anticipated
policy changes. Maintaining fiscal discipline was and is still a major challenge for
Governments of Ghana. Stability can be achieve through conscious effort
towards: Stable monetary growth, managing money supply with the hope of
maintaining prices; maintaining fiscal deficit/ (surplus) during recession/
(expansion) by establishing automatic stabilizers.

These findings differ from the hypothesized expectations only in the case of
inflation. Expected inflation have a positive relation with the GSE but it was

56
expected that unanticipated inflation will have negative impact on the exchange
but results of this study contradict that expectation. The justification could be that
the pricing mechanism is very effective in inflation forecasting. Depreciation of
the currency have negative impact on the GSE All Share Index but the short run
adjusting coefficient suggests that depreciation of the Ghana Cedi could have
positive relation with the market.

6.0 Conclusions

1. This paper examined the long and short run relationships between five (5)
macroeconomic variables and Ghana Stock Exchange All Share Index for
the period of eighteen (18) years, from January 1991 to December 2008.
The macroeconomic factors considered were Gross Domestic Product,
Fiscal balance, Inflation, Interest Rates and Exchange rate.

2. There is no economic theory that explains the linkage between

macroeconomic variables and stock market performance in any one
direction but there are several macroeconomic factors that have been
identified as having an impact on stock prices. This study used dividend
discount model to select the variables used in the study.

3 The existence of cointegration between the variables was tested by

establishing the order of cointegration, using unit roots test and then by
performing rank tests using Johansen procedure to establish long run
relationships before error correction and granger causality test were used
to establish short term relation ships.

4 The effects of macroeconomic factors on the performance of stock

markets cannot be generalized in a set in hypothesis or theories that is
applicable to all nations. There are country differences depending on the

57
 structure of the economy and the policy transmission mechanism. Stock
returns are normally influences by both international and local conditions.

5 The results of cointegration indicated single cointegration vector between

the GSI and the macroeconomic factors examined. The coefficients from
the cointegration vector normalized on GSE provided evidence of long run
relationship between the GSI and the economic variables considered.
The results provided evidence that the Ghana Stock Exchange is
positively related to GDP and Inflation, and negatively related to Interest
rates, Fiscal movements and Exchange rate fluctuations.

6 Empirical evidence in this study support expected relationship between

the performance of the GSI and the macroeconomic variables considered,
with the exception of Inflation. This possibly reflects the fact that Inflation
expectation is factored in the pricing mechanism of the economy so only
unanticipated inflationary movement can have a negative impact on the
Ghana Stock Market and the economy at large. This suggests that the
Bank of Ghana’s Inflation targeting regime may be working well. It is also
possible that the use of nominal rates instead of real rates might have
contributed to this result. Depreciation of the currency have negative
impact on the GSE All Share Index but the short run adjusting coefficient
suggests that depreciation of the Ghana Cedi could have positive relation
with the Exchange. The pace of adjustment is however slow.

7 The role of Government in crafting and implementing fiscal and monetary

policies have significant impact on the economy and therefore the Capital
Market but there are other factors like oil price hikes; change of
Government; international financial and economic development etc. which
have major impact on the economy of Ghana, but these do not form part
of this study.

58
8 Ghana has a well though out fiscal and monetary policy but the policy
transmission mechanism has some challenges, largely because of
implementation of economic policy without careful consideration of the
period of lags on macroeconomic factors. Maintaining fiscal discipline was
and is still a major challenge for past and current Governments of Ghana.
Governments wishing to promote economic growth may endeavour to
maintain incremental macroeconomic stability. They should avoid budget
deficits and excessive surpluses. Time lags in recognition, implementation
and impact of policy should also be monitored and controlled to ensure
policy interventions yield desired results.

9 Ghanaian policy makers need to be careful when trying to influence the

economy through in macroeconomic factors. The oil fine for instance is
expected to lead to increased supply of foreign currency, this may be
channeled into to economy to solve problems of unemployment, and this
may lead to excessive appreciation of the currency making export from
other sectors less competitive. Increased money supply may also lead to
inflation.

10 This study emphasise the importance of lag in the implementation of

economic policy. The lags include recognition, implementation and impact.
The impact lag is shorter for fiscal policy than monetary policy.
Unanticipated changes have greater impact than anticipated policy
changes.

11 The Government of Ghana is concerned about stability and growth.

12 The lag length used for the error correction in this study may be a
limitation and may account for reasons of disparity in results when this
study is compared with other studies conducted on the GSI.

59
8.0 Recommendations

1. The Government of Ghana is concerned about stability and growth. Greater

stability can be achieved if the Government of Ghana establishes the
following through the Bank of Ghana and the Ministry of Finance.

 Stable monetary growth to match the future growth potential of the

economy.
 Manage money supply with the hope of maintaining prices;
 Maintain fiscal deficit or surpluses during recession and periods of
expansion respectively;
 Use automatic stabilizers like unemployment benefits during periods of
low economic activities, high corporate taxes during booms and low
corporate taxes during recession, and wider coverage and progressive
personal income tax regimes.
 Use of Oil revenues with caution to avoid negative impact on
macroeconomic variables.

2. The policy transmission mechanism needs to be studied thoroughly to

understand why it takes so long a time for the impact of policy to be felt in
both the Economy and the Stock Market. The lags in policy identification,
implementation and impact should be studied and carefully eliminated to
ensure intended actions do not have lagged effects.

60
 3. Future studies of Ghana Stock Exchange and macroeconomic factors
should use real rate of returns instead of nominal rates.

8.0 Reflections

Research work on this topic began when I met Dr. Tomasz Wisniewski at the
2008 Summer School. I went to the Summer School at the time I was considering
my dissertation topic. I wanted to research into Mortgage Finance for the
Ghanaian Worker. A research I wanted to conduct to enable me to develop a
proposal on mortgage finance. I was very clear in my mind during discussions
with Dr. Wisniewski that I could develop a proposal separately from my
dissertation to achieve that purpose. We discussed my second option, a study of
the Macroeconomics factors that affect Stock Market returns. This topic ignited a
lot of interest in him. He helped in shaping up the topic and got some references
on the topic for me.

I spent some time at the library reading around the topic before meeting my
dissertation supervisor Dr. C.B Tse. He approved the topic and probed further
into the areas I intended to cover, he gave me valuable advice in the process. He
was very helpful in subsequent discussions when I was developing the proposal.
He helped in clarifying the research questions and objectives as well as some
aspects of the methodology. Dr. Tse’s comments on my Dissertation Proposal
A.G.C form became I major source of reference throughout the period of the
dissertation. His guidance was clear as to what I must do.

The research questions and objectives of the dissertation were well defined and
fulfilled at the end of the process. Some few changes were made from what was
anticipated at the proposal stage. At the proposal stage, I considered total
returns comprising capital gains/losses and dividends yield as the best way of
measuring stock market performance. Dividend yield data was not available for

61
most period of the study. I consider this a limitation, but market index must not
necessarily have dividend yield. Stock Indexes are computed differently from one
Stock Exchange to another. I was also not clear on whether I was looking at
individual stock returns or the composite Index at the proposal stage.

The outcomes compared quite well with the expected results. Inflation was
expected to have a negative relationship with the Ghana All Share Index, but it
turned out to have positive relationship this might have resulted from the use of
nominal returns. Nominal returns and inflation are likely to be positively
correlated as inflation can drive nominal earnings and where real interest rates
are negative due to high inflation, investors will seek solace in the stock market.
to seek higher returns. This was experience in Zimbabwe where galloping
inflation drove the local stock market up in local currency terms.

The research was well planned and executed to a large extent. Data collection
and literature review was done on time. I realized at the stage of methodology
review that the software I had for the analysis – SPSS was inadequate. The
scope of analysis involved unit roots, co-integration and error correction
techniques among others used in the realm of econometrics. I spent
considerable amount of time looking for the appropriate software and I spent over
three months to get it. Leaning to use the software was a big challenge. I
overcame that by concentrating my effort on the modules I needed to analyse my
data and interpret the results.

Data availability was a major problem of this research. Data on Fiscal balance
and GDP were available only annually. The analysis was done on monthly basis
so the annual data was repeated for twelve (12) months. I should have looked for
the software used for data projection to ensure the annual data was projected
randomly for each month. The use of real rates instead of nominal rates
contributed to the results I got. I should have used real market returns rate at
least.

62
The learning process was tremendous. The dissertation was the second half of
my studies. It involved consolidating all what I learnt for the assignments and
examinations. I acquire more analytical skills than in the first stage of my studies.
I also delved more into the area of Economics and Econometrics. I acquired vital
skills that I have started employing in my work. In fact I can pass the test for a
Macroeconomic Analyst. It was a fulfilling experience.

It is good our Tutors are not allowed to help with the methodology and analysis of
data. This helped to develop skills in finding answers to critical questions. I
however want to recommend that they are allowed to propose software, give
guidance on how to use and review the findings to ensure that the research
results and interpretations are relevant and consistent.

I hope my study has added to existing knowledge about the fact that there are
lags in the effect of changes in macroeconomic factors on the Ghanaian
Economy and the Stock Market. The transmission mechanism of policy need
further study to identify why the lags and what can be done to correct it.

63
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Richard A. Brealey, Stewart C Myers and Franklin Allen (2006) Corporate

Finance, Mc Graw Hill Irwin, Eighth Edition
Steve Lumby and Chris Jones (2003) Corporate Finance, Theory and Practice,
Thomson, London, Seventh Edition.

64
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Ghana, Legon, The State of the Ghanaian Economy in 2008, Sundel Services,
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Management: Issues and Approaches for Firms, IMF Working Paper, November
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Research Working Paper, The World Bank WPS 907

67
Poon, S and Taylor, S.J (1991) Macro economic factors and UK Stock Markets,

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Representation, estimation and Testing, Econometrica Vol. 55 No. 2 pp 251-279

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Stock Returns: Evidence from Turkey. International Research Journal of Finance

and Economics Issue 16

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variables, Applied Financial Economics, pgs 55-60

Ramir C. Maysami, Lee C.Howe and Mohamad A. Hamzah (2004), Relationship

between Macroeconomic variables and Stock Market Indices: Co integration

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Pengurusan pg.47-77

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Wan Mansor Mahmood and Nazihah Dimmiah (2009) Stock Market and

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10.0 Appendices

Appendix A: Unit Root Tests

Null Hypothesis: GSE has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -2.704533 0.0749

Test critical values: 1% level -3.460739
5% level -2.874804
10% level -2.573917

69
*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GSE)
Method: Least Squares
Date: 11/12/09 Time: 23:41
Sample (adjusted): 1991M02 2008M12
Included observations: 215 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

GSE(-1) -0.063786 0.023585 -2.704533 0.0074

C 3.093824 1.529424 2.022869 0.0443

R-squared 0.033200 Mean dependent var 0.307023

Adjusted R-squared 0.028661 S.D. dependent var 16.81485
S.E. of regression 16.57213 Akaike info criterion 8.462580
Sum squared resid 58497.34 Schwarz criterion 8.493935
Log likelihood -907.7274 Hannan-Quinn criter. 8.475249
F-statistic 7.314497 Durbin-Watson stat 1.941587
Prob(F-statistic) 0.007393

Null Hypothesis: GDP has a unit root

Exogenous: Constant
Lag Length: 12 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic 0.264663 0.9759

Test critical values: 1% level -3.462574
5% level -2.875608
10% level -2.574346

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GDP)
Method: Least Squares
Date: 11/12/09 Time: 23:42
Sample (adjusted): 1992M02 2008M12
Included observations: 203 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

GDP(-1) 0.004573 0.017277 0.264663 0.7916

D(GDP(-1)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-2)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-3)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-4)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-5)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-6)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-7)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-8)) -0.006391 0.057128 -0.111867 0.9110

70
D(GDP(-9)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-10)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-11)) -0.006391 0.057128 -0.111867 0.9110
D(GDP(-12)) -0.565930 0.063158 -8.960575 0.0000
C -0.003606 0.083464 -0.043204 0.9656

R-squared 0.301070 Mean dependent var 0.016749

Adjusted R-squared 0.252996 S.D. dependent var 0.225405
S.E. of regression 0.194816 Akaike info criterion -0.367052
Sum squared resid 7.173155 Schwarz criterion -0.138555
Log likelihood 51.25580 Hannan-Quinn criter. -0.274612
F-statistic 6.262569 Durbin-Watson stat 2.015487
Prob(F-statistic) 0.000000

Null Hypothesis: FISCAL has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.402818 0.5805

Test critical values: 1% level -3.460739
5% level -2.874804
10% level -2.573917

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(FISCAL)
Method: Least Squares
Date: 11/12/09 Time: 23:43
Sample (adjusted): 1991M02 2008M12
Included observations: 215 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

FISCAL(-1) -0.024668 0.017585 -1.402818 0.1621

C -0.189035 0.107440 -1.759449 0.0799

R-squared 0.009154 Mean dependent var -0.074465

Adjusted R-squared 0.004503 S.D. dependent var 1.025897
S.E. of regression 1.023585 Akaike info criterion 2.893757
Sum squared resid 223.1655 Schwarz criterion 2.925112
Log likelihood -309.0789 Hannan-Quinn criter. 2.906426
F-statistic 1.967899 Durbin-Watson stat 1.979723
Prob(F-statistic) 0.162127

Null Hypothesis: FISCAL has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

71
 t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.402818 0.5805

Test critical values: 1% level -3.460739
5% level -2.874804
10% level -2.573917

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(FISCAL)
Method: Least Squares
Date: 11/12/09 Time: 23:43
Sample (adjusted): 1991M02 2008M12
Included observations: 215 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

FISCAL(-1) -0.024668 0.017585 -1.402818 0.1621

C -0.189035 0.107440 -1.759449 0.0799

R-squared 0.009154 Mean dependent var -0.074465

Adjusted R-squared 0.004503 S.D. dependent var 1.025897
S.E. of regression 1.023585 Akaike info criterion 2.893757
Sum squared resid 223.1655 Schwarz criterion 2.925112
Log likelihood -309.0789 Hannan-Quinn criter. 2.906426
F-statistic 1.967899 Durbin-Watson stat 1.979723
Prob(F-statistic) 0.162127

Null Hypothesis: INTEREST has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.619225 0.4710

Test critical values: 1% level -3.460884
5% level -2.874868
10% level -2.573951

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(INTEREST)
Method: Least Squares
Date: 11/12/09 Time: 23:45
Sample (adjusted): 1991M03 2008M12

72
Included observations: 214 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

INTEREST(-1) -0.015563 0.009612 -1.619225 0.1069

D(INTEREST(-1)) 0.327816 0.064929 5.048848 0.0000
C 0.461285 0.295219 1.562519 0.1197

R-squared 0.114110 Mean dependent var 0.031168

Adjusted R-squared 0.105713 S.D. dependent var 1.783227
S.E. of regression 1.686340 Akaike info criterion 3.896918
Sum squared resid 600.0297 Schwarz criterion 3.944104
Log likelihood -413.9702 Hannan-Quinn criter. 3.915985
F-statistic 13.58926 Durbin-Watson stat 2.033122
Prob(F-statistic) 0.000003

Null Hypothesis: INFLATION has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -2.281634 0.1789

Test critical values: 1% level -3.460884
5% level -2.874868
10% level -2.573951

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(INFLATION)
Method: Least Squares
Date: 11/12/09 Time: 23:46
Sample (adjusted): 1991M03 2008M12
Included observations: 214 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

INFLATION(-1) -0.041270 0.018088 -2.281634 0.0235

D(INFLATION(-1)) 0.166896 0.067898 2.458056 0.0148
C 0.957790 0.529575 1.808602 0.0719

R-squared 0.044909 Mean dependent var -0.044720

Adjusted R-squared 0.035856 S.D. dependent var 4.471243
S.E. of regression 4.390351 Akaike info criterion 5.810615
Sum squared resid 4067.063 Schwarz criterion 5.857801
Log likelihood -618.7358 Hannan-Quinn criter. 5.829682
F-statistic 4.960662 Durbin-Watson stat 2.042697
Prob(F-statistic) 0.007847

Null Hypothesis: EXCHANGE has a unit root

Exogenous: Constant
Lag Length: 3 (Automatic based on SIC, MAXLAG=14)

73
 t-Statistic Prob.*

Augmented Dickey-Fuller test statistic 0.045087 0.9607

Test critical values: 1% level -3.461178
5% level -2.874997
10% level -2.574019

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(EXCHANGE)
Method: Least Squares
Date: 11/12/09 Time: 23:47
Sample (adjusted): 1991M05 2008M12
Included observations: 212 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

EXCHANGE(-1) 0.000636 0.014110 0.045087 0.9641

D(EXCHANGE(-1)) -0.680179 0.069524 -9.783422 0.0000
D(EXCHANGE(-2)) -0.411622 0.078696 -5.230500 0.0000
D(EXCHANGE(-3)) -0.188433 0.068597 -2.746958 0.0065
C 0.011922 0.008675 1.374317 0.1708

R-squared 0.323581 Mean dependent var 0.005486

Adjusted R-squared 0.310510 S.D. dependent var 0.090184
S.E. of regression 0.074885 Akaike info criterion -2.322422
Sum squared resid 1.160810 Schwarz criterion -2.243257
Log likelihood 251.1767 Hannan-Quinn criter. -2.290425
F-statistic 24.75580 Durbin-Watson stat 2.042473
Prob(F-statistic) 0.000000

Null Hypothesis: D(GSE) has a unit root

Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -14.59452 0.0000

Test critical values: 1% level -2.575813
5% level -1.942317
10% level -1.615712

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GSE,2)
Method: Least Squares
Date: 11/13/09 Time: 00:00
Sample (adjusted): 1991M03 2008M12

74
Included observations: 214 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

D(GSE(-1)) -1.000000 0.068519 -14.59452 0.0000

R-squared 0.500000 Mean dependent var 3.24E-17

Adjusted R-squared 0.500000 S.D. dependent var 23.83953
S.E. of regression 16.85709 Akaike info criterion 8.492082
Sum squared resid 60526.43 Schwarz criterion 8.507811
Log likelihood -907.6528 Hannan-Quinn criter. 8.498438
Durbin-Watson stat 2.000000

Null Hypothesis: D(GDP) has a unit root

Exogenous: None
Lag Length: 11 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -8.031221 0.0000

Test critical values: 1% level -2.576403
5% level -1.942399
10% level -1.615659

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GDP,2)
Method: Least Squares
Date: 11/13/09 Time: 00:03
Sample (adjusted): 1992M02 2008M12
Included observations: 203 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

D(GDP(-1)) -1.562757 0.194585 -8.031221 0.0000

D(GDP(-1),2) 0.562757 0.186483 3.017740 0.0029
D(GDP(-2),2) 0.562757 0.178012 3.161339 0.0018
D(GDP(-3),2) 0.562757 0.169118 3.327603 0.0011
D(GDP(-4),2) 0.562757 0.159729 3.523201 0.0005
D(GDP(-5),2) 0.562757 0.149753 3.757915 0.0002
D(GDP(-6),2) 0.562757 0.139062 4.046802 0.0001
D(GDP(-7),2) 0.562757 0.127479 4.414525 0.0000
D(GDP(-8),2) 0.562757 0.114731 4.905004 0.0000
D(GDP(-9),2) 0.562757 0.100378 5.606382 0.0000
D(GDP(-10),2) 0.562757 0.083596 6.731904 0.0000
D(GDP(-11),2) 0.562757 0.062456 9.010524 0.0000

R-squared 0.679433 Mean dependent var 0.006897

Adjusted R-squared 0.660971 S.D. dependent var 0.334415
S.E. of regression 0.194717 Akaike info criterion -0.377244
Sum squared resid 7.241718 Schwarz criterion -0.181389
Log likelihood 50.29025 Hannan-Quinn criter. -0.298009
Durbin-Watson stat 2.000000

75
Null Hypothesis: D(FISCAL) has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -14.59452 0.0000

Test critical values: 1% level -2.575813
5% level -1.942317
10% level -1.615712

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(FISCAL,2)
Method: Least Squares
Date: 11/13/09 Time: 00:06
Sample (adjusted): 1991M03 2008M12
Included observations: 214 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

D(FISCAL(-1)) -1.000000 0.068519 -14.59452 0.0000

R-squared 0.500000 Mean dependent var -3.96E-18

Adjusted R-squared 0.500000 S.D. dependent var 1.458083
S.E. of regression 1.031020 Akaike info criterion 2.903636
Sum squared resid 226.4195 Schwarz criterion 2.919365
Log likelihood -309.6891 Hannan-Quinn criter. 2.909992
Durbin-Watson stat 2.000000

Null Hypothesis: D(INTEREST) has a unit root

Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -10.45987 0.0000

Test critical values: 1% level -2.575813
5% level -1.942317
10% level -1.615712

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(INTEREST,2)
Method: Least Squares
Date: 11/13/09 Time: 00:07
Sample (adjusted): 1991M03 2008M12
Included observations: 214 after adjustments

76
Variable Coefficient Std. Error t-Statistic Prob.

D(INTEREST(-1)) -0.678698 0.064886 -10.45987 0.0000

R-squared 0.339348 Mean dependent var 0.000187

Adjusted R-squared 0.339348 S.D. dependent var 2.077908
S.E. of regression 1.688934 Akaike info criterion 3.890734
Sum squared resid 607.5820 Schwarz criterion 3.906463
Log likelihood -415.3085 Hannan-Quinn criter. 3.897090
Durbin-Watson stat 2.025256

Null Hypothesis: D(INFLATION) has a unit root

Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -12.59545 0.0000

Test critical values: 1% level -2.575813
5% level -1.942317
10% level -1.615712

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(INFLATION,2)
Method: Least Squares
Date: 11/13/09 Time: 00:09
Sample (adjusted): 1991M03 2008M12
Included observations: 214 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

D(INFLATION(-1)) -0.853802 0.067787 -12.59545 0.0000

R-squared 0.426873 Mean dependent var 0.003224

Adjusted R-squared 0.426873 S.D. dependent var 5.842968
S.E. of regression 4.423428 Akaike info criterion 5.816369
Sum squared resid 4167.711 Schwarz criterion 5.832098
Log likelihood -621.3515 Hannan-Quinn criter. 5.822725
Durbin-Watson stat 2.029338

Null Hypothesis: D(EXCHANGE) has a unit root

Exogenous: None
Lag Length: 2 (Automatic based on SIC, MAXLAG=14)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -12.87578 0.0000

Test critical values: 1% level -2.575916
5% level -1.942331

77
 10% level -1.615703

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(EXCHANGE,2)
Method: Least Squares
Date: 11/13/09 Time: 00:09
Sample (adjusted): 1991M05 2008M12
Included observations: 212 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

D(EXCHANGE(-1)) -2.208807 0.171547 -12.87578 0.0000

D(EXCHANGE(-1),2) 0.550403 0.128172 4.294249 0.0000
D(EXCHANGE(-2),2) 0.167253 0.068310 2.448428 0.0152

R-squared 0.765762 Mean dependent var 0.000146

Adjusted R-squared 0.763520 S.D. dependent var 0.155273
S.E. of regression 0.075508 Akaike info criterion -2.315111
Sum squared resid 1.191599 Schwarz criterion -2.267612
Log likelihood 248.4018 Hannan-Quinn criter. -2.295913
Durbin-Watson stat 2.027093

Appendix B Cointegration Tests

Date: 11/12/09 Time: 22:14

Sample (adjusted): 1992M05 2008M12
Included observations: 200 after adjustments
Trend assumption: Linear deterministic trend
Series: GSE GDP FISCAL INTEREST INFLATION EXCHANGE
Exogenous series: GSE
Warning: Critical values assume no exogenous series
Lags interval (in first differences): 10 to 15

Unrestricted Cointegration Rank Test (Trace)

Hypothesized Trace 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 1.000000 7252.115 95.75366 1.0000

At most 1 0.097235 43.38458 69.81889 0.8780
At most 2 0.061947 22.92592 47.85613 0.9622
At most 3 0.028151 10.13615 29.79707 0.9782
At most 4 0.021875 4.425093 15.49471 0.8664

78
At most 5 7.84E-06 0.001569 3.841466 0.9664

Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 1.000000 7208.731 40.07757 1.0000

At most 1 0.097235 20.45866 33.87687 0.7241
At most 2 0.061947 12.78977 27.58434 0.8962
At most 3 0.028151 5.711057 21.13162 0.9880
At most 4 0.021875 4.423524 14.26460 0.8122
At most 5 7.84E-06 0.001569 3.841466 0.9664

Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I):

GSE GDP FISCAL INTEREST INFLATION EXCHANGE

0.086428 -6.48E-17 1.68E-17 1.82E-17 1.92E-18 1.14E-15
-0.015378 1.369137 0.094127 -0.025806 0.025669 -3.641976
-0.007799 0.958362 0.359203 0.087470 -0.014088 2.115365
0.005749 0.081881 -0.034294 -0.023885 -0.088472 -1.769332
-0.002715 -0.432681 0.019389 -0.091327 0.007549 1.295989
0.004471 -1.113663 0.105148 -0.078724 -0.022024 -0.795081

Unrestricted Adjustment Coefficients (alpha):

D(GSE) -11.57028 4.86E-16 0.000000 -6.25E-17 -6.31E-16 3.63E-16

D(GDP) -0.030146 -0.022179 0.010309 0.002382 0.019208 -0.000204
D(FISCAL) 0.040699 -0.029287 -0.059222 -0.100283 -0.056497 -0.000494
D(INTEREST) -0.025498 0.192802 -0.214564 -0.081938 0.127323 0.001117
D(INFLATION) -0.428142 -0.642663 -0.486953 0.051840 0.105047 0.002208
D(EXCHANGE) -0.000442 0.004460 -0.008441 0.003766 -0.001092 -0.000114

1 Cointegrating Equation(s): Log likelihood 2103.563

Normalized cointegrating coefficients (standard error in parentheses)

GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 -4.19E-16 3.12E-16 2.14E-16 -3.81E-18 1.21E-14
(3.8E-08) (7.2E-09) (2.9E-09) (1.8E-09) (9.0E-08)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000
(1.6E-09)
D(GDP) -0.002605
(0.00116)
D(FISCAL) 0.003518
(0.00528)

79
D(INTEREST) -0.002204
(0.01025)
D(INFLATION) -0.037004
(0.02077)
D(EXCHANGE) -3.82E-05
(0.00041)

2 Cointegrating Equation(s): Log likelihood 2113.792

Normalized cointegrating coefficients (standard error in parentheses)

GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 0.000000 3.41E-16 2.07E-16 4.04E-18 1.10E-14
(6.6E-09) (2.4E-09) (1.8E-09) (8.7E-08)
0.000000 1.000000 0.068749 -0.018849 0.018748 -2.660052
(0.06129) (0.02233) (0.01652) (0.81049)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000 -6.17E-16
(1.6E-09) (2.6E-08)
D(GDP) -0.002264 -0.030366
(0.00117) (0.01827)
D(FISCAL) 0.003968 -0.040098
(0.00535) (0.08350)
D(INTEREST) -0.005169 0.263972
(0.01032) (0.16102)
D(INFLATION) -0.027121 -0.879894
(0.02062) (0.32162)
D(EXCHANGE) -0.000107 0.006106
(0.00041) (0.00642)

3 Cointegrating Equation(s): Log likelihood 2120.187

Normalized cointegrating coefficients (standard error in parentheses)

GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 0.000000 0.000000 8.38E-17 4.13E-17 5.54E-15
(2.4E-09) (1.8E-09) (8.0E-08)
0.000000 1.000000 0.000000 -0.043584 0.026262 -3.753379
(0.02859) (0.02110) (0.95919)
0.000000 0.000000 1.000000 0.359796 -0.109288 15.90316
(0.15051) (0.11110) (5.04924)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000 -9.91E-16 -6.49E-16
(1.7E-09) (3.1E-08) (7.0E-09)
D(GDP) -0.002345 -0.020486 0.001615
(0.00117) (0.02226) (0.00495)
D(FISCAL) 0.004430 -0.096854 -0.024029
(0.00536) (0.10163) (0.02258)
D(INTEREST) -0.003495 0.058342 -0.058924
(0.01026) (0.19451) (0.04322)
D(INFLATION) -0.023323 -1.346572 -0.235407
(0.02042) (0.38731) (0.08606)
D(EXCHANGE) -4.09E-05 -0.001983 -0.002612
(0.00041) (0.00776) (0.00172)

80
4 Cointegrating Equation(s): Log likelihood 2123.043

Normalized cointegrating coefficients (standard error in parentheses)

GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 0.000000 0.000000 0.000000 -9.50E-16 -4.09E-15
(1.8E-09) (6.0E-08)
0.000000 1.000000 0.000000 0.000000 0.541869 1.254711
(0.24056) (8.27790)
0.000000 0.000000 1.000000 0.000000 -4.365727 -25.43963
(1.97620) (68.0037)
0.000000 0.000000 0.000000 1.000000 11.83014 114.9062
(5.44791) (187.470)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000 -2.85E-15 -5.12E-16 -1.39E-16
(1.7E-09) (3.1E-08) (7.0E-09) (1.8E-09)
D(GDP) -0.002331 -0.020291 0.001534 0.001417
(0.00118) (0.02228) (0.00497) (0.00126)
D(FISCAL) 0.003853 -0.105065 -0.020590 -0.002029
(0.00533) (0.10089) (0.02248) (0.00568)
D(INTEREST) -0.003966 0.051633 -0.056114 -0.021786
(0.01026) (0.19444) (0.04333) (0.01096)
D(INFLATION) -0.023025 -1.342327 -0.237185 -0.027247
(0.02046) (0.38771) (0.08641) (0.02184)
D(EXCHANGE) -1.93E-05 -0.001675 -0.002741 -0.000943
(0.00041) (0.00775) (0.00173) (0.00044)

5 Cointegrating Equation(s): Log likelihood 2125.255

Normalized cointegrating coefficients (standard error in parentheses)

GSE GDP FISCAL INTEREST INFLATION EXCHANGE
1.000000 0.000000 0.000000 0.000000 0.000000 4.57E-15
(5.6E-08)
0.000000 1.000000 0.000000 0.000000 0.000000 -3.684719
(0.84149)
0.000000 0.000000 1.000000 0.000000 0.000000 14.35637
(5.61631)
0.000000 0.000000 0.000000 1.000000 0.000000 7.067903
(13.7584)
0.000000 0.000000 0.000000 0.000000 1.000000 9.115549
(14.6348)

Adjustment coefficients (standard error in parentheses)

D(GSE) -1.000000 1.53E-15 -2.17E-16 -1.51E-16 -1.76E-17
(1.7E-09) (3.2E-08) (7.0E-09) (2.5E-09) (1.8E-09)
D(GDP) -0.002383 -0.028602 0.001906 -0.000337 -0.000780
(0.00117) (0.02287) (0.00494) (0.00174) (0.00124)
D(FISCAL) 0.004007 -0.080620 -0.021686 0.003131 0.008528
(0.00531) (0.10392) (0.02245) (0.00789) (0.00562)
D(INTEREST) -0.004312 -0.003457 -0.053645 -0.033414 0.016182
(0.01023) (0.20008) (0.04323) (0.01520) (0.01082)
D(INFLATION) -0.023310 -1.387779 -0.235148 -0.036841 -0.013429
(0.02046) (0.40021) (0.08647) (0.03039) (0.02165)
D(EXCHANGE) -1.63E-05 -0.001203 -0.002763 -0.000844 -0.000108
(0.00041) (0.00801) (0.00173) (0.00061) (0.00043)

81
Appendix C Vector Error Correction

Vector Error Correction Estimates

Date: 11/16/09 Time: 20:43
Sample (adjusted): 1992M05 2008M12
Included observations: 200 after adjustments
Standard errors in ( ) & t-statistics in [ ]

Cointegrating Eq: CointEq1

GSE(-1) 1.000000

GDP(-1) -4.19E-16
(3.8E-08)
[-1.1e-08]

FISCAL(-1) 3.12E-16
(7.2E-09)
[ 4.3e-08]

INTEREST(-1) 2.14E-16
(2.9E-09)
[ 7.5e-08]

INFLATION(-1) -3.81E-18
(1.8E-09)
[-2.1e-09]

EXCHANGE(-1) 1.21E-14
(9.0E-08)
[ 1.3e-07]

C -47.49835

Error Correction: D(GSE) D(GDP) D(FISCAL) D(INTEREST) D(INFLATION) D(EXCHANGE)

CointEq1 -1.000000 -0.002605 0.003518 -0.002204 -0.037004 -3.82E-05

(1.6E-09) (0.00116) (0.00528) (0.01025) (0.02077) (0.00041)
[-6.2e+08] [-2.23989] [ 0.66682] [-0.21502] [-1.78167] [-0.09390]

D(GSE(-10)) 7.19E-16 -0.000152 0.000775 -0.010068 -0.005407 0.000310

(0.00031

(2.8E-16) (0.00089) (0.00405) (0.00786) (0.01593) )

[ 2.53123] [-0.17087] [ 0.19150] [-1.28042] [-0.33937] [ 0.99365]

D(GSE(-11)) 6.90E-16 -0.000968 0.002059 -0.011282 -0.008492 0.000116

(3.0E-16) (0.00094) (0.00427) (0.00830) (0.01682) (0.00033)
[ 2.30141] [-1.02778] [ 0.48196] [-1.35936] [-0.50495] [ 0.35350]

D(GSE(-12)) 4.65E-16 0.000434 0.024626 -0.003405 -0.024618 0.000166

82
 (3.0E-16) (0.00094) (0.00428) (0.00832) (0.01687) (0.00033)
[ 1.54716] [ 0.45893] [ 5.74768] [-0.40904] [-1.45935] [ 0.50333]

D(GSE(-13)) 3.65E-16 0.000285 -0.002128 0.012899 -0.007515 0.000630

(3.0E-16) (0.00094) (0.00424) (0.00824) (0.01671) (0.00033)
[ 1.22465] [ 0.30458] [-0.50153] [ 1.56457] [-0.44981] [ 1.92561]

D(GSE(-14)) 6.11E-16 -0.000323 -0.000651 0.013997 -0.003076 -0.000992

(3.0E-16) (0.00094) (0.00427) (0.00829) (0.01680) (0.00033)
[ 2.04263] [-0.34343] [-0.15245] [ 1.68813] [-0.18308] [-3.01502]

D(GSE(-15)) 5.09E-16 -0.000413 -0.001746 0.014149 0.001238 0.000260

(3.0E-16) (0.00094) (0.00425) (0.00826) (0.01674) (0.00033)
[ 1.70473] [-0.44049] [-0.41061] [ 1.71242] [ 0.07395] [ 0.79281]

D(GDP(-10)) 2.14E-14 -0.016497 0.078959 -0.396103 -0.871318 0.005712

(1.9E-14) (0.06024) (0.27319) (0.53080) (1.07563) (0.02106)
[ 1.11663] [-0.27384] [ 0.28902] [-0.74624] [-0.81005] [ 0.27126]

D(GDP(-11)) 2.05E-14 0.001861 0.016807 -0.355297 -0.355861 0.008058

(2.0E-14) (0.06268) (0.28425) (0.55229) (1.11917) (0.02191)
[ 1.02847] [ 0.02969] [ 0.05913] [-0.64332] [-0.31797] [ 0.36777]

D(GDP(-12)) -1.71E-14 -0.480877 -0.800928 -1.949335 -8.696853 0.002579

(2.5E-14) (0.07867) (0.35674) (0.69313) (1.40458) (0.02750)
[-0.68440] [-6.11290] [-2.24510] [-2.81236] [-6.19176] [ 0.09379]

D(GDP(-13)) -2.50E-16 0.007041 0.067641 0.110381 -0.555260 0.064677

(2.5E-14) (0.07718) (0.35000) (0.68004) (1.37805) (0.02698)
[-0.01017] [ 0.09123] [ 0.19326] [ 0.16232] [-0.40293] [ 2.39735]

D(GDP(-14)) 1.33E-14 -0.012254 -0.007006 0.280976 0.066474 -0.069348

(2.4E-14) (0.07674) (0.34802) (0.67618) (1.37023) (0.02683)
[ 0.54358] [-0.15968] [-0.02013] [ 0.41554] [ 0.04851] [-2.58515]

D(GDP(-15)) 1.87E-14 0.023830 -0.055932 0.502816 1.292227 -0.003448

(2.5E-14) (0.07747) (0.35134) (0.68264) (1.38332) (0.02708)
[ 0.75988] [ 0.30759] [-0.15920] [ 0.73658] [ 0.93415] [-0.12731]

D(FISCAL(-10)) 7.78E-15 0.000543 -0.019736 -0.003457 -0.038714 0.000555

(4.3E-15) (0.01349) (0.06120) (0.11890) (0.24094) (0.00472)
[ 1.81274] [ 0.04026] [-0.32250] [-0.02907] [-0.16068] [ 0.11770]

D(FISCAL(-11)) 6.46E-15 -0.001657 -0.026801 -0.099805 -0.323720 0.002243

(4.4E-15) (0.01372) (0.06221) (0.12087) (0.24493) (0.00480)
[ 1.47951] [-0.12080] [-0.43082] [-0.82574] [-1.32169] [ 0.46782]

D(FISCAL(-12)) -1.30E-14 0.022213 -0.109272 -0.073174 -1.074510 -0.003135

(6.2E-15) (0.01936) (0.08779) (0.17058) (0.34566) (0.00677)
[-2.10347] [ 1.14742] [-1.24465] [-0.42898] [-3.10855] [-0.46322]

D(FISCAL(-13)) -9.70E-16 -0.002467 -0.028709 -0.119251 -0.430108 0.005912

(5.2E-15) (0.01629) (0.07387) (0.14353) (0.29085) (0.00569)
[-0.18725] [-0.15147] [-0.38862] [-0.83085] [-1.47879] [ 1.03827]

D(FISCAL(-14)) -4.28E-15 0.008130 -0.011928 -0.030489 -0.291839 -0.006676

(5.2E-15) (0.01647) (0.07467) (0.14508) (0.29399) (0.00576)

83
 [-0.81770] [ 0.49376] [-0.15974] [-0.21016] [-0.99269] [-1.16001]

D(FISCAL(-15)) -5.59E-15 0.008333 -0.016999 -0.048210 -0.122737 -0.001022

(5.4E-15) (0.01694) (0.07681) (0.14925) (0.30244) (0.00592)
[-1.03711] [ 0.49198] [-0.22130] [-0.32302] [-0.40582] [-0.17261]

D(INTEREST(-10)) 2.04E-15 0.005415 -0.002938 -0.011812 0.151722 0.000331

(2.9E-15) (0.00908) (0.04119) (0.08003) (0.16217) (0.00317)
[ 0.70592] [ 0.59615] [-0.07133] [-0.14760] [ 0.93557] [ 0.10421]

D(INTEREST(-11)) -1.67E-15 -0.004287 -0.012522 -0.002783 -0.026305 0.002317

(3.0E-15) (0.00943) (0.04276) (0.08308) (0.16836) (0.00330)
[-0.55825] [-0.45465] [-0.29284] [-0.03349] [-0.15625] [ 0.70311]

D(INTEREST(-12)) 3.70E-15 0.011480 0.009621 0.100497 -0.148226 -0.002291

(3.0E-15) (0.00943) (0.04277) (0.08310) (0.16840) (0.00330)
[ 1.23184] [ 1.21719] [ 0.22493] [ 1.20932] [-0.88021] [-0.69504]

D(INTEREST(-13)) 4.65E-16 -0.011573 -0.047040 0.016120 -0.096941 0.008141

(3.0E-15) (0.00929) (0.04214) (0.08188) (0.16592) (0.00325)
[ 0.15717] [-1.24538] [-1.11626] [ 0.19688] [-0.58427] [ 2.50625]

D(INTEREST(-14)) 1.29E-15 0.002931 0.013053 -0.038140 -0.196962 -0.009235

(3.0E-15) (0.00938) (0.04255) (0.08266) (0.16751) (0.00328)
[ 0.43184] [ 0.31238] [ 0.30680] [-0.46138] [-1.17581] [-2.81591]

D(INTEREST(-15)) -2.21E-15 0.005779 -0.039280 0.010323 0.010184 0.002268

(3.0E-15) (0.00930) (0.04217) (0.08193) (0.16602) (0.00325)
[-0.74689] [ 0.62149] [-0.93153] [ 0.12600] [ 0.06134] [ 0.69791]

D(INFLATION(-10)) -2.27E-15 0.001634 -0.010695 0.027787 0.073150 -0.001317

(1.3E-15) (0.00395) (0.01790) (0.03478) (0.07048) (0.00138)
[-1.81149] [ 0.41402] [-0.59742] [ 0.79889] [ 1.03783] [-0.95463]

D(INFLATION(-11)) -1.34E-15 0.008373 -0.019505 0.046215 0.100027 -0.001202

(1.4E-15) (0.00449) (0.02037) (0.03957) (0.08019) (0.00157)
[-0.93810] [ 1.86437] [-0.95770] [ 1.16794] [ 1.24745] [-0.76595]

D(INFLATION(-12)) 1.68E-15 -0.023058 0.064343 -0.070728 -0.334116 -0.000947

(1.4E-15) (0.00455) (0.02063) (0.04008) (0.08123) (0.00159)
[ 1.16317] [-5.06860] [ 3.11889] [-1.76455] [-4.11346] [-0.59553]

D(INFLATION(-13)) 4.08E-16 0.003059 -0.001759 -0.067503 0.040414 0.010353

(1.4E-15) (0.00456) (0.02067) (0.04015) (0.08137) (0.00159)
[ 0.28122] [ 0.67126] [-0.08513] [-1.68114] [ 0.49668] [ 6.49926]

D(INFLATION(-14)) -1.41E-15 0.002205 0.002746 -0.080652 0.005960 -0.008943

(1.5E-15) (0.00459) (0.02080) (0.04041) (0.08188) (0.00160)
[-0.96771] [ 0.48071] [ 0.13205] [-1.99595] [ 0.07278] [-5.57879]

D(INFLATION(-15)) -2.47E-16 0.000674 0.012964 -0.067805 -0.061624 -0.000191

(1.5E-15) (0.00458) (0.02076) (0.04034) (0.08175) (0.00160)
[-0.16949] [ 0.14712] [ 0.62436] [-1.68078] [-0.75382] [-0.11950]

D(EXCHANGE(-10)) 5.18E-14 0.418113 -0.471814 2.366684 7.854994 -0.048635

(8.4E-14) (0.26484) (1.20104) (2.33355) (4.72878) (0.09258)

84
 [ 0.61520] [ 1.57872] [-0.39284] [ 1.01420] [ 1.66110] [-0.52534]

D(EXCHANGE(-11)) -1.80E-14 -0.249798 -0.602574 3.992407 -19.14410 -0.079326

(1.0E-13) (0.31712) (1.43811) (2.79416) (5.66219) (0.11085)
[-0.17806] [-0.78771] [-0.41900] [ 1.42884] [-3.38105] [-0.71561]

D(EXCHANGE(-12)) -3.25E-14 -0.113871 -0.502796 2.163403 -13.91016 0.424000

(1.0E-13) (0.32095) (1.45546) (2.82788) (5.73050) (0.11219)
[-0.31835] [-0.35480] [-0.34545] [ 0.76503] [-2.42739] [ 3.77936]

D(EXCHANGE(-13)) -7.44E-14 -0.029103 -0.188057 -0.621776 -10.36970 -0.029424

(9.5E-14) (0.29952) (1.35828) (2.63906) (5.34788) (0.10470)
[-0.78129] [-0.09717] [-0.13845] [-0.23560] [-1.93903] [-0.28104]

D(EXCHANGE(-14)) -3.74E-14 0.041360 0.151280 -2.006919 -6.894862 -0.015817

(7.7E-14) (0.24089) (1.09242) (2.12251) (4.30113) (0.08420)
[-0.48820] [ 0.17170] [ 0.13848] [-0.94554] [-1.60303] [-0.18783]

D(EXCHANGE(-15)) -2.66E-14 0.009984 0.088028 -1.313086 -3.928232 -0.005145

(6.0E-14) (0.18735) (0.84964) (1.65079) (3.34521) (0.06549)
[-0.44652] [ 0.05329] [ 0.10361] [-0.79543] [-1.17429] [-0.07856]

C -47.49835 -0.111118 0.060797 -0.028536 -2.053467 0.005762

(1.8E-14) (0.05678) (0.25748) (0.50026) (1.01374) (0.01985)
[-2.6e+15] [-1.95713] [ 0.23613] [-0.05704] [-2.02563] [ 0.29032]

GSE 1.000000 0.002735 -0.002456 -0.000518 0.043512 -3.29E-05

(3.7E-16) (0.00115) (0.00522) (0.01014) (0.02054) (0.00040)
[ 2.7e+15] [ 2.37736] [-0.47080] [-0.05113] [ 2.11823] [-0.08184]

R-squared 1.000000 0.431654 0.355578 0.272909 0.558877 0.584641

Adj. R-squared 1.000000 0.297510 0.203478 0.101298 0.454761 0.486606
Sum sq. resides 5.90E-25 5.832479 119.9482 452.8057 1859.414 0.712664
S.E. equation 6.05E-14 0.190333 0.863145 1.677038 3.398405 0.066532
F-statistic 4.34E+29 3.217848 2.337793 1.590273 5.367835 5.963584
Log likelihood 69.69982 -232.6620 -365.5023 -506.7576 279.9186
Akaike AIC -0.306998 2.716620 4.045023 5.457576 -2.409186
Schwarz SC 0.336174 3.359792 4.688195 6.100748 -1.766014
Mean dependent 0.308450 0.017000 -0.048500 -0.003650 -0.080350 0.005793
S.D. dependent 17.43455 0.227088 0.967131 1.769030 4.602373 0.092855

Determinant resid covariance (dof adj.) 1.07E-29

Determinant resid covariance 2.92E-30
Log likelihood 2038.733
Akaike information criterion -17.98733
Schwarz criterion -14.02935

Appendix D Granger Causality Tests

Pairwise Granger Causality Tests

Date: 12/15/09 Time: 02:28
Sample: 1991M01 2008M12

85
Lags: 15

Null Hypothesis: Obs F-Statistic Prob.

D(GDP) does not Granger Cause D(GSE) 200 0.00737 1.0000

D(GSE) does not Granger Cause D(GDP) 0.17419 0.9998

D(FISCAL) does not Granger Cause D(GSE) 200 8.47020 3.E-14

D(GSE) does not Granger Cause D(FISCAL) 4.45240 5.E-07

D(INTEREST) does not Granger Cause D(GSE) 200 1.96324 0.0205

D(GSE) does not Granger Cause D(INTEREST) 1.03754 0.4194

D(INFLATION) does not Granger Cause D(GSE) 200 1.84887 0.0318

D(GSE) does not Granger Cause D(INFLATION) 0.81252 0.6627

D(EXCHANGE) does not Granger Cause D(GSE) 200 3.49212 3.E-05

D(GSE) does not Granger Cause D(EXCHANGE) 2.31336 0.0051

D(FISCAL) does not Granger Cause D(GDP) 200 0.02838 1.0000

D(GDP) does not Granger Cause D(FISCAL) 0.00673 1.0000

D(INTEREST) does not Granger Cause D(GDP) 200 0.72316 0.7588

D(GDP) does not Granger Cause D(INTEREST) 2.50056 0.0023

D(INFLATION) does not Granger Cause D(GDP) 200 0.94117 0.5200

D(GDP) does not Granger Cause D(INFLATION) 1.54747 0.0937

D(EXCHANGE) does not Granger Cause D(GDP) 200 0.16560 0.9999

D(GDP) does not Granger Cause D(EXCHANGE) 4.25301 1.E-06

D(INTEREST) does not Granger Cause D(FISCAL) 200 0.45075 0.9609

D(FISCAL) does not Granger Cause D(INTEREST) 0.75964 0.7204

D(INFLATION) does not Granger Cause D(FISCAL) 200 1.96425 0.0205

D(FISCAL) does not Granger Cause D(INFLATION) 4.56255 3.E-07

D(EXCHANGE) does not Granger Cause D(FISCAL) 200 0.31808 0.9931

D(FISCAL) does not Granger Cause D(EXCHANGE) 2.37359 0.0040

D(INFLATION) does not Granger Cause D(INTEREST) 200 2.46927 0.0027

D(INTEREST) does not Granger Cause D(INFLATION) 0.19328 0.9996

D(EXCHANGE) does not Granger Cause D(INTEREST) 200 1.40261 0.1509

D(INTEREST) does not Granger Cause D(EXCHANGE) 1.90364 0.0258

D(EXCHANGE) does not Granger Cause D(INFLATION) 200 5.73895 2.E-09

D(INFLATION) does not Granger Cause D(EXCHANGE) 11.8985 1.E-19

Appendix F: Proposal Template

86
 Electronic AGC FORM (PROPOSAL)
SECTION 1: STUDENT TO COMPLETE
NAME: I.D. No: ENROLMENT/START DATE
SAMUEL YAO DAGADU 069018828 04/07

PROGRAMME: MODULE: DATE SUBMITTED LOCAL RESOURCE CENTRE

MSc FINANCE THE PROPOSAL 29/05/2009 QDL – GHANA
STUDENT DECLARATION: In submitting work to the University you are agreeing to the following statement:
“I declare that this assignment is my own work, that all sources of reference are acknowledged in full and that it has not been submitted for any other
course“.

SECTION 2: TUTOR’S COMMENTS

Ability to construct
a project with clear,
coherent and well
defended research
questions/
objectives

Discussion of the
relation between
your proposed
research and
previous research

Discussion and
justification of
proposed methods

Overall Comments:

Second Marker Additional Comments (Optional):

87
SECTION 3: TUTOR’S COMMENTS - Ethical Review Process:
Ethics Approval 1. None Required (student not doing research on live human subjects)
Decision Route:
(Delete as appropriate) 2. Automatic
3. Committee [School] [Faculty] [University]
Does this Project have
Comment:
Ethics Approval? 1. Yes
(Delete as appropriate)
2. No

Tutor marking this assignment Date of marking Mark Awarded (%) Grade Awarded

88
 School of Management
Dissertation Proposal Pro-Forma
Version 1.3 (November 2008)
Section 1: The Proposal Template

Your Name, Programme of Study, Student Number, Centre & Intake.

SAMUEL YAO DAGADU, MSc FINANCE, 069018828, QDL-GHANA, APRIL 2007

Please identify any University of Leicester Tutors with whom you have discussed your
proposal and the forum you used (e.g. workshops/Blackboard)

Dr. C B TSE. SUMMER SCHOOL, 2008

Title (max. 15 words)

Macroeconomic Variables and Stock Market Performance: Case study of Ghana Stock Exchange

Abstract (max. 200 words)

This proposal is a prelude to a study of short run and long run relationships between
macroeconomic variables and returns of listed stocks on the Ghana Stock Exchange using
the Granger causality, Co integration techniques and Error Correction Models.
Macroeconomic variables of interest are Fiscal deficit/surpluses, Inflation, Interest rates
and Exchange rates.

Economic factors that impact on changing investment opportunities and dividends

directly impact pricing and performance of listed equity securities on the Ghana Stock
exchange. The Government of Ghana has a key role to play in ensuring a sound capital
market through macroeconomic measures, fiscal environment- taxation; legal, regulatory
and institutional infrastructure.

This study is important for the formulation of both fiscal and monetary policy.
Individuals, Pension Funds and other Institutional Investors invest in the Stock market to
ensure future stream of income. Erosion of capital in the market due to macroeconomic
in-balances has dire consequences for both individual stock holders and Fund
participants.

Earlier studies on the Ghana Stock Exchange, reported on the impact of inflation, interest
rates, foreign direct investments, exchange rates etc on the market. No study considered
the effect of fiscal imbalances on the Ghana Stock Market.

Introduction (approx. 200 words)

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The Ghanaian economy had experienced macroeconomic instability over long periods of
time. Macroeconomic instability had negative effects on the Ghana Stock Exchange. It is
not clear from available statistics and earlier studies on the Ghana Stock Exchange, the
macroeconomic factor or combination of factors that are responsible for the performance
of the exchange. In 1993 for instance, Inflation rose to 70% when, Interest rates was
30.95% and the Stock exchange recorded a performance rate of 116.06%. GDP grew in
that year by 4.9%. In 1999, Inflation was as low as 21.3% and Interest rate was 34.19%
but the stock performance was (15.14) % and GDP grew by 4.4%.

The question then is:

1: What macroeconomic factors drive the Ghana Stock exchange?

2: How does fiscal deficits/surpluses, inflation rates, interest rates and exchange
rates impact
on the Ghana Stock Exchange?

Finding answers to these questions will help add to existing knowledge about the
underlying causes of price movement of the Ghana Stock Exchange and how these
variables can be used to predict market returns. It will be useful in giving policy
guidelines to ensure stability of the capital market. It will also be a useful guide to
Investors and Financial Analyst in assessing the price of stocks and their systematic risks
with anticipated changes in the macroeconomic factors.

Relation to previous research (approx. 400 words)

Fama (1981), Smith and Sims (1993), identified inflation, money supply, exchange rates
as some of the major determinants of stock prices. Chen, Roll and Ross (1986)
established the existence of long term equilibrium between stock prices and Inflation,
Treasury–bill rate, Long term government bonds, Industrial production etc. Robert Pardy
(1992), emphasised the role of macroeconomic and fiscal environment in the
development and performance of securities market.

According to Fama (1981) and other writers, inflation have negative relationship with
stock performance because high inflation rates add to uncertainty which reduces business
confidence and thus lowers stock returns, but studies on Ghana examined below indicate
positive relationships with inflation. This is in line with Choudhry (2001) who
investigated some developing Countries. Exchange rates have both positive and negative
effect on stock prices depending on whether the stock is from a net import or export
oriented company.

Adam, Anokye and Tweneboah, (2008), examined the long and short term relationship
between interest rate, inflation rate, net foreign direct investment, and exchange rate and
the Ghana stock market during the period January 1991 to December 2006, using co
integration and error correction models. They concluded that there is long run

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relationship between stock prices and some of the macroeconomic factors examined.
They found out that there is a positive relationship between inflation and share prices.

Twerefou and Nimo (2005) investigated the impact of asset pricing of the various sectors
of the Ghana Stock Exchange for the period January 1997 to December 2002 using
arbitrage pricing method. The study concluded that inflation, short term interest rates and
term structure of interest rates are macroeconomic factors affecting asset pricing in
Ghana.

Kyereboah-Coleman and Agyire-Tettey (2008) used quarterly time series data of the
following macroeconomic factors: Inflation, Real Exchange rates, Interest rates, and
Lending rates to examine the effect of these macroeconomic factors on the performance
of the Ghana Stock Exchange. They concluded that lending rates have an adverse effect
on stock performance and Inflation had a lagged effect on stock performance. They were
certain on the fact that depreciation favours investors.

This study will have a base on the macroeconomic relationships established with stock
exchange performance by Fama, Chen Roll, Ross and others, but it will be based on the
concepts of co integration and causality instead of Arbitrage Pricing Theory. Unlike all
the studies on Ghana Stock Exchange, emphasis will not only be on what factors affect
the stock market performance but also on causality of these factors. Moreover the effect
of fiscal imbalance on the stock market will be examined.

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Proposed methods (approx. 400 words)

Time series data from January 1991 to December 2008 will be used in the model. Data on
Fiscal deficit and Inflation will be obtained from the Statistical Service of Ghana,
Treasury bill rates and year on year exchange rate movements will be obtained from the
Bank of Ghana. Ghana Stock Exchange All Share Index (GSI) which measures only price
movements will be approximated by Databank Stock Index (DSI). The DSI is the
depended variable of the regression equation. It represents the performance indicator of
the stock market. Fiscal Deficits/Surpluses will capture the income and expenditure position
of the economy; Interest rates will be approximated by 91 day Treasury bills; Inflation rate
and Exchange rates are the other independent variables.

The model is DSI = b0 + b1FD + b2INTrate + b3INFrate + b4EXrate + et Eq1

where DSI is the Databank Stock Index, FD is Fiscal Deficit, INTrate is interest rate,
INFrate is inflation rate, EXrate is the exchange rate, b0 - b4 are coefficients of variables
and et is the error term, representing others factors not considered e.g. Oil price hike and
change in Government.

Visual inspection of the time series data will be done to observe and comment on
movement in the variables. The time series data of each variable will undergo logarithmic
transformation to stabilise the variances. Unit roots test using Augmented Dickey Fuller
(ADF) will be undertaken to ascertain the order of integration of each variable to ensure
stationarity of the variables. Granger causality tests using bivariate vector autoregressive
method will be conducted to examine short term causal relationships between the stock
returns and each variable by calculating F statistic.

To establish long term relationships and co-movement among the variables, Co

integration techniques by Granger (1986) and Engle and Granger (1987) will be used.
The original time series data will be used to conduct an Ordinary least Squares regression
between two variables at a time under the model

Yt = a + Bxt + ut Eq2

Where, ut is the estimated residuals on the long run equilibrium. The residuals are then
subjected to unit root test. If co integration is confirmed with any variable, then Johansen
and Juselius (1990) Error Correction Model will be used to establish long run causal
relationship between the two variables.

Multiple regression analysis alone will not be able to answer the research questions since
the variables of interest are interdependent and the analysis will require a test of the
stationarity of the data and establish the causality of price movement and dependencies of
the variables. Arbitrage Pricing Theory will not be useful for this study.

Reflections (approx. 500 words)

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The success of this work depends largely on the availability, and frequency of data; my ability to
interpret the results and understand the real drivers of returns of the Ghana Stock Exchange.

Total returns comprising capital gains/losses and dividends yield is the best way of measuring
stock market performance but dividend yield data may not be available for most period of the
study. This will limit stock returns to only capital gains or price changes. This may not show the
true performance of the Stock Market, because it is possible for some companies to post good
financial performance and pay high dividends during periods of low patronage of the Stock
exchange, but because of lack of investor interest in the stock market, prices of these companies
will not reflect the economic fundamentals but rather follow the general trend of a bearish
market.

Timeliness and frequency of data, in a study of this nature is paramount. It will be ideal to use
monthly time series data but information on Fiscal deficits for instance, which is key in this
analysis cannot be obtained monthly. Using annual data will give us only eighteen (18) regression
points (1991-2008) as against two hundred and sixteen (216) points using monthly data. This may
limit the fine details required for effective time series analysis.

The analysis may go beyond the capability of Excel, it will involve finding logs, unit roots, co-
integration and error correction techniques used in the realm of econometrics. My ability to
interpret the results will depend on how quickly I grasp the techniques involved.

The Economy of Ghana like most developing countries defy the principles of economics
espoused in text books. Inflation can for instance be more than the rates for treasury instruments
and yet treasury instruments will be considered more viable than investment in the capital
markets. I hope this study will confirm the results of other studies on macroeconomic relationship
with stock markets in developing countries.

Government’s fiscal and monetary policies have significant effect on the economy and therefore
the Capital Market. Other factors like oil price hikes; change of Government; international
financial and economic development, have major impact on the economy of Ghana, but these do
not form part of this study.

It is difficult to say whether the Ghana Stock Exchange is efficient or not, it is difficult to depend
on past price movements to make gains but the same cannot be said of release of information.
Some Companies announce good returns and prospects but nothing happens to their prices.

Government’s debt financing cause interest rates to rise and this directly cause Inflation
and depreciation. Depreciation results in capital flights. Investors not having confidence
in the economy divert resources from the long term investments to short term treasury
bills and consumables or real estate. Listed Companies are staved of needed resources to
finance viable projects since they cannot borrow at the prevailing high interest rates.
They become less competitive and their profit levels fall leading to a fall in returns.

Conclusion (max. 200 words)

Government have a key role in creating macroeconomic disequilibrium leading to high
inflation and interest rates, devaluations and fiscal deficits among others which impact
negatively on the stock market.

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Participants in the stock market anticipate real returns from the stock market so stock
prices will move inversely with inflation. Investors directly compare earning yield on
stocks with treasury yields and move funds from one market to the other, an inverse
relationship between stock returns and interest rates is expected. Fiscal deficits increase
Government borrowing which increases interest rates, which crowd out private
individuals and businesses, denying listed companies of much needed capital resulting in
low returns. Depreciation of the cedi leads to decrease in the prices of exports and
increase in demand, which leads to increase cash-flows. A weak currency increase the
price of imported goods so Companies of a net importing Country like Ghana will suffer
with currency depreciation.

After submission of this proposal, I shall wait for the results to start data collection and
writing of the dissertation. I shall in the interim continue with literature review, studying
research methodology, and learn about the econometric analytical tools I shall employ to
analyse the data.

Timetable (approx. 100 words, or a one page diagram)

JUNE
AUG 2008 SEPT 08 TO APRIL 09
MAY 09 09 JULY 09

SEP TO DEC JAN TO WK

Event/ Date Wk 3 08 APRIL MAY JUNE WK1 WK2 WK3 4 WK5
Agree topic with Supervisor
Initial Literature Review
Proposal Writing
Proposal Submission (May 29)
Literature Review
Research Methodology
Data Collection
Learning of Analysis Methods
Proceed on Leave
Data Analysis
Writing of Dissertation
Results & Analysis
Conclusions
References Finalization
Final Editing
Proof-Reading
Submission

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References

Journals

Adam, Anokye and Tweneboah, (2008) Macroeconomic Factors and Stock Market
Movement: Evidence from Ghana, MPRA Paper No. 11256, October2008

Anthony Kyereboah –Coleman and Kwame F. Agyire – Tettey (2008) Impact of

Macroeconomic indicators on stock market performance. The case of Ghana Stock
Exchange. Journal of Risk Finance, Vol. 9. No. 4 pages 365-378.

Chen N.F., Roll R. and Ross S, (1986) Economic Forces and Stock Markets, Journal of
Business, pgs 383-403

Choudhry, T. (2001) Inflation and rates of return on stocks: evidence from high inflation
Countries, Journal of International Financial Markets, Institutional Investors and Money,
pgs 75-96

Fama and Schwert (1977) Asset returns and inflation, Journal of Financial Economics,
pgs 115-146

Fama, (1981) Stock returns, real activity, inflation and money, American Economic
Review, pgs 269-282

Fama, (1991) Efficient Capital Markets: II, Journal of Finance, pgs 1575-1618

Pardy, Robert, (1992) Institutional Reform in Emerging Securities Markets, Policy

Research Working Paper, The World Bank WPS 907

Smith K and Sims A, (1993) Stock Market Performance and Macroeconomic variables,
Applied Financial Economics, pgs 55-60

Twerefou D.K and Michael K. Nimo, (2005) The Impact of Macroeconomic Risk on
Asset Prices in Ghana, 1997 – 2002, African Development Bank 2005

Utku Utkulu How to estimate long run relationships in economics: An overview of

recent developments, Dokuz Eylul University Working paper

Appendices (optional)

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Section 2: University of Leicester School of Management - Initial Ethical Review
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