The links between stock prices and economic factors in European countries : a quantitative study

Abstract

This study examines the relationship between stock prices and macroeconomic variables within Belgium, France, Germany, Netherlands and Portugal. These relationships were evaluated through the Ordinary Least Squares (OLS) method and the Granger-Causality test via the Unrestricted Vector Autoregressive (VAR) model. Preliminary OLS models were used to select the variables which are statistically significant in the variability in stock prices. VAR estimations were then used to model stock prices along with the most significant variable for the respective country. The selected macroeconomic variables are inflation, money supply, interest rates and industrial production index. The most significant macroeconomic factor explaining stock prices is interest rates in the case of Germany and Portugal and industrial production index for Belgium and France. None of the macroeconomic variables were statistically significant in explaining stock price movements in Netherlands. There is a unidirectional Granger-causality from stock prices to industrial production index for Belgium and France. In the case of Germany, there is a unidirectional Granger-causality from stock prices to interest rates, however, there is no such Granger-causality in case of Portugal. These results are in line with the prior strand of literature which suggests that stock prices are leading indicators.