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FX: In the data set that is given, a negative relation is suggested between stock prices and the exchange rate. As the exchange rate falls, demand for stocks increase and hence stock prices go up. However, empirical studies from other countries have shown otherwise. For example, a study of four Asian countries over a six year period using monthly data concluded that there was no short run relationship between exchange rates and stock prices (Muhammad and Rasheed: 10). The research was carried out using applied cointegration, error correction modelling approach and standard Granger causality tests which are more complicated than the techniques to be applied in this report. .
MS: In general a positive relationship has been suggested between money supply and stock prices. Some empirical studies do suggest that this theory is debatable. For example, Rogalski and Vinso (1977: 1027-9) find in their research that causality runs from stock prices to money supply and can possibly run back. So the money supply can affect stock prices but the initial causality is concluded to run from stock price to money supply in this study. .
The above relationships have shown to exist in the current real world economic environment. Fir example, in the U.S, industrial production rose by 0.9% in November following which stock prices rose in December, showing evidence of the positive relationship between stock price and industrial production. The rise in stock prices was also attributed to a fall in core consumer inflation and a rise in Treasury bond prices. Following the theory behind the relationship between interest rates and bond prices, it can be assumed that due to the increase in bond prices, interest rates may have fallen hence there is indirect evidence of the negative relationship between stock prices and interest rates (http://money.cnn.com).
METHODOLOGY.
The following regression equations will be used to model the effects of the macroeconomic variables on stock price:.
