The impact of macroeconomic indicators on stock prices in vietnam

UNIVERSITY OF ECONOMICS HO CHI MINH CITY International School of Business --- HUYNH THANH DUNG THE IMPACT OF MACROECONOMIC INDICATORS ON STOCK PRICES IN VIETNAM MASTER OF BUSINE

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

International School of Business

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HUYNH THANH DUNG

THE IMPACT OF MACROECONOMIC INDICATORS

ON STOCK PRICES IN VIETNAM

MASTER OF BUSINESS (Honours)

SUPERVISOR: Dr PHAM QUOC HUNG

Ho Chi Minh City – 2013

*

ACKNOWLEDGEMENTS

Firstly, I would like to express my very great appreciation to my supervisor – Dr Pham Quoc Hung – for his enthusiastic guidance, valuable and constructive suggestions during the planning and development of this thesis

I would also like to thank all of my lecturers at International School of Business (ISB) – University of Economics Ho Chi Minh City (UEH) – for sharing their knowledge and experience during my master course Enthusiastic assistance provided by the ISB’s executive board and staffs was also greatly appreciated

I am grateful to all my friends and classmates form MBus 2 – ISB for their support

Finally, I would like to express my special thanks to my wife for her support and encouragement throughout my study

Keywords: Stock price, macroeconomic variables, cointegation, VECM

TABLE OF CONTENT

ACKNOWLEDGEMENTS i

ABSTRACT ii

TABLE OF CONTENT iii

LIST OF FIGURES vi

LIST OF TABLES vii

LIST OF ABBREVIATIONS ix

CHAPTER 1: INTRODUCTION 1

1.1 Research background 1

1.2 Research problems 4

1.3 Research objectives 5

1.4 Significance of the research 5

1.6 Research methodology and scope 6

1.7 Research structure 7

CHAPTER 2: LITERATURE REVIEW 9

2.1 Theoretical framework 9

2.1.1 The top-down approach 9

2.1.2 The dividend valuation model 10

2.2 Relationship between industrial production and stock price 11

2.3 Relationship between interest rate and stock price 13

2.4 Relationship between inflation and stock price 17

2.5 Relationship between exchange rate and stock price 20

2.6 Hypotheses summary 23

2.7 Research model 24

CHAPTER 3: RESEARCH METHODOLOGY 25

3.1 Research process 25

3.2 Measurement of variables 26

3.2.1 Dependent variable 26

3.2.2 Independent variables 26

3.3 Data collection and sample size 27

3.4 Model specification 28

3.5 Method of data analysis 28

3.5.1 Unit root test 29

3.5.2 The order of integration 31

3.5.3 Cointegration concept 31

3.5.4 Cointegration test 32

3.5.5 Vector Error Correction Model 33

CHAPTER 4: DATA ANALYSIS AND RESULTS 35

4.1 Descriptive statistics 35

4.2 Correlation analysis 37

4.3 Unit root test 38

4.4 Cointegration test 39

4.4.1 Optimal lag length selection 39

4.4.2 Cointegration test 40

4.5 Hypotheses testing 42

4.5.1 The long run relationship 43

4.5.2 The short run relationship 46

4.6 Diagnostic tests 51

4.6.1 Autocorrelation test 51

4.6.2 Normality test 52

4.6.3 Heteroskedasticity test 53

CHAPTER 5: CONCLUSIONS AND IMPLICATIONS 54

5.1 Conclusions 54

5.2 Implications 56

5.3 Limitations and further research 57

REFERENCES 59

APPENDICES 62

LIST OF FIGURES

Figure 1.1 VN-Index from January 2001 to May 2013 3

Figure 2.1 VN-Index and Industrial Production Index 13

Figure 2.2 VN-Index and Interest Rate 17

Figure 2.3 VN-Index and CPI 20

Figure 2.4 VN-Index and Exchange Rate 23

Figure 2.5 Conceptual model 24

Figure 3.1 Research process 25

LIST OF TABLES

Table 3.1 Description of variables 27

Table 4.1 Descriptive information 35

Table 4.2 Correlation matrix 37

Table 4.3 Result of unit root test at levels 38

Table 4.4 Result of unit root test after first differencing 38

Table 4.5 VAR lag order selection criteria 40

Table 4.6 Result of cointegration test 41

Table 4.7 Result of cointegrating vector 43

Table 4.8 Result of long run relationship 44

Table 4.9 Result of short run relationship 47

Table 4.10 Hypotheses testing summary 50

Table 4.11 Result of autocorrelation 51

Table 4.12 Result of normality test 52

Table 4.13 Result of heteroskedasticity 53

Table A1 Correlation Matrix 62

Table A2 Result of ADF test for LVN 63

Table A3 Result of ADF test for D(LVN) 63

Table A4 Result of ADF test for LIP 64

Table A5 Result of ADF test for D(LIP) 65

Table A6 Result of ADF test for LIR 66

Table A7 Result of ADF test for D(LIR) 67

Table A8 Result of ADF test for LCPI 67

Table A9 Result of ADF test for D(LCPI) 68

Table A10 Result of ADF test for LEXR 69

Table A11 Result of ADF test for D(LEXR) 70

Table A12 Result of optimal lag length selection 71

Table A13 Result of cointegration test 71

Table A14 Result of VECM 75

Table A15 Result of coefficients of ECM 76

Table A16 Serial correlation LM test 77

Table A17 Correlogram Q-statistics 79

Table A18 Heteroskedasticity test 80

LIST OF ABBREVIATIONS

CAPM Capital Asset Pricing Model

GSO General Statistic Office

HNX-Index Hanoi Stock Price Index

IFS International Financial Statistics

IPI Industrial Production Index

IPO Initial Public Offering

SPSS Statistical Package for the Social Sciences

VAR Vector Autoregressive

VECM Vector Error Correction Model

VN-Index Vietnamese Stock Price Index

CHAPTER 1: INTRODUCTION

This chapter introduces the background of the stock market including the Vietnamese stock market Next, the research problems and research objectives are identified Furthermore, the significance and scope of the research are also presented Finally, the research structure gives an overview of the structure organized in this study

1.1 Research background

It is undeniable the importance of the stock market in the financial system

of any economy In both developed and developing countries, it becomes a significant component of a country’s financial system and plays very important roles in the economy One of the major roles that the stock market plays is to mobilize the savings By mobilizing of savings, stock markets help to bridge the gap between savers and investors in an economy Stock markets provide services and benefits to governments, enterprises, and investors In fact, governments themselves can issue bonds on the stock market to raise money for infrastructure,

or other major projects As regards the corporations, they are able to make an initial public offering (IPO) on the stock exchange to mobilize new capital for their business Moreover, the stock market is also a place where investors can diversify their portfolio in order to reduce the risks by investing in different stocks Stock price, therefore, becomes a matter of general concern of people including

government, enterprises, and investors The question of which factors that affects the stock prices is of serious concern to the investors all over the world

In economic theory, the price is mostly affected by supply and demand relationship This principle is also true for the stock price If the demand for a share is greater than its supply, there will be an increase in share price Conversely, the share price will fall if the supply for a share is higher than the demand Beyond the basic microeconomic factors such as supply and demand, the relationship between stock prices and macroeconomic variables such as industrial production, interest rates, inflation rates, exchange rate has been the subject of various studies

in the field of economy and finance in the last decades A number of studies carried out in developed market like U.S (Chen, Roll & Ross, 1986) and Japan (Mukherjee & Naka, 1995) reveal that the macroeconomic factors have an impact

on stock prices These studies have paved the way for further examination of similar relations in emerging markets such as Singapore, Thailand, Malaysia, Indonesia and Philippines (Wongbangpo & Sharma, 2002), Vietnam (Hussainey & Ngoc, 2009), and Jordan (El-Nader & Alraimony, 2012)

The Vietnamese stock market, which comprises of the Ho Chi Minh Stock Exchange (HOSE) and Hanoi Stock Exchange (HNX), is one of the emerging markets in Asia The HOSE and HNX were established in July 2000 and March

2005, respectively and they have made significant contributions to the economy Like other emerging markets in Asia, the Vietnamese stock market is attracting attention as a market that can bring good returns for investors As the figure 1.1

shows, after a period of rapid growth in stock prices from the beginning to the end

of 2007, however, there was a significant decline in Vietnamese stock prices from the end of 2007 onwards The year of 2007 is the year that the Vietnamese stock market was in a stock market bubble The stock price index reached a peak at 1170.7 points in March 2007 There are many factors leading to the fluctuations in Vietnamese stock price, such as international and domestic economic uncertainty, psychology of investors Despite the fact that the Vietnamese stock market is potential for investors, there is limited empirical study investigating the relationship between stock prices and economic indicators, especially macroeconomic indicators (Hussainey & Ngoc, 2009) Therefore, the question of whether or not the macroeconomic indicators affect Vietnamese stock prices is also concerned

Figure 1.1 VN-Index from January 2001 to May 2013

Source: Ho Chi Minh Stock Exchange (HOSE)

1.2 Research problems

Many researchers investigate the impact of macroeconomic variables on stock prices and offer evidence that macroeconomic variables affect stock prices such as Chen, et al (1986) for US; Mukherjee and Naka (1995) for Japan; Wongbangpo and Sharma (2002) for five Asian countries namely, Singapore, Thailand, Malaysia, Indonesia and Philippines; and (2005) for Turkey; and El-Nader and Alraimony (2012) for Jordan However, the findings of these researches are quite different or even opposite in different countries For instance, Wongbangpo and Sharma (2002) determine a negative relation between interest rate and stock price in Singapore, Thailand and Philippines, but a positive relation is found in Indonesia and Malaysia

Furthermore, there exits limited study regarding the examination of how macroeconomic indicators influence stock prices in emerging markets, especially

in Vietnam (Hussainey & Ngoc, 2009) Hussainey and Ngoc also state that their study is the first study that investigates the effects of macroeconomic indicators on Vietnamese stock prices They believe that their paper provides a significant contribution to the existing literature, as the authors are the first to examine this issue in Vietnam Nevertheless, the limitation of their study is that this study only examines the impact of two domestic macroeconomic indicators (namely interest rate and industrial production), and international factors (US macroeconomic indicators) on stock prices Their recommendation is that other macroeconomic variables should be included in the model in order to make the results become more valid

1.3 Research objectives

The main aim of this study is to examine the impact of four key macroeconomic indicators, namely industrial production index, interest rates, inflation rates, and exchange rates on Vietnamese stock prices More specifically, the purpose of this study is to answer the following questions:

● Do the long run and short run relationship between selected macroeconomic indicators and Vietnamese stock prices exist?

● How do macroeconomic indicators affect the stock price in long run and short run?

1.4 Significance of the research

Since the Vietnamese stock market is still immature, it is necessary to have more and more researches into the Vietnamese stock market so that people can understand more about the stock market and help develop the stock market in a sustainable way By examining the relationship between macroeconomic indicators and stock price, the findings of this paper are expected to offer implications that can help the policy makers, managers of listed companies and investors to predict how the stock price changes if macroeconomic indicators fluctuate

More specifically, based on the results of this study, policy makers can evaluate the impact of their policies, such as fiscal policy, monetary policy on stock market Therefore, they can formulate better policies that efficiently and timely adjust the Vietnamese stock market

Apart from helping policy makers, the results of this study can help managers of listed companies to understand the impact of external factors on the stock prices of the company and thereby keeping the stock prices steady

Moreover, the findings drawn from this study can help the investors understand more about the volatility of the stock market as a measure of risk Therefore, they can make the right decision in order to avoid risks and make more profits based on their understanding of macroeconomic information For instance,

if the finding shows that an increase in inflation rate reduces the stock price, the investors should adjust their portfolios by selling the stock and moving to other assets that are more profitable

1.6 Research methodology and scope

This study confines itself in investigation of the relationship between stock prices in Ho Chi Minh Stock Exchange (VN-Index) and four selected macroeconomic variables, namely industrial production, interest rate, inflation rate and exchange rate The relationship between HNX - Index and these macroeconomic variables is beyond the scope of this study In addition, this study only uses 65 monthly observations from January 2008 to May 2013 for data analysis The analysis includes the following steps:

● Descriptive statistics analysis

● Using ADF test to test the stationary of all time series data

● Using cointegration test to check whether there exists a long run relationship among variables or not

● Applying Vector Error Correction Model to investigate the long run as well as the short run relationship if there is a cointegration relationship among variables

Eviews software version 6.0, SPSS version 16.0 software and Microsoft Excel software are used as data analysis tools

1.7 Research structure

This research is divided into different chapters and each chapter covers some areas of the research The structure of the research is as follows:

Chapter 1: Introduction: This chapter depicts general information about the

research including research background, research problems, research objectives, significance and limitations of the research

Chapter 2: Literature review: The relevant literature on the research is reviewed in

this chapter, including financial theories and previous empirical studies regarding the relationship between macroeconomic factors and stock prices In addition, the hypotheses, which are tested in this research, are also set

Chapter 3: Research methodology: This chapter discusses about the research

process, measurement of variables, data collection and methods of data analysis employed in this study

Chapter 4: Data analysis and results: Collected data are analyzed in this part in

order to investigate the relationship between macroeconomic variables

and stock price In addition, the results obtained from empirical research are also analyzed

Chapter 5: Conclusions and implications: This chapter is all about conclusions of

this study, implications, limitations, and recommendations for further studies relating to the research topic

CHAPTER 2: LITERATURE REVIEW

This chapter reviews relevant theories as well as the findings of previous empirical studies regarding the relationship between selected four macroeconomics and stock prices Based upon these studies, hypotheses and conceptual model are proposed

2.1 Theoretical framework

There are many theories that mention the relationship between macroeconomic variables and stock prices This study bases on two of them, namely the top-down approach and dividend valuation model or present value

model in order to explain that relationship

2.1.1 The top-down approach

In the valuation process, top-down approach, which is a process of gathering and organizing information about economic, industry and company, is used to determine the intrinsic value of an ordinary share (Gitman, Joehnk, Juchau, Wheldon and Wright, 2004) This approach includes three steps: economic analysis, industry analysis and company analysis The top-down approach believes that both economy and industry have a significant impact on the company and its stock price Therefore, some macroeconomic variables should be taken into account in the share valuation process In other words, there exists a relationship between macroeconomic factors and stock prices

2.1.2 The dividend valuation model

According to Gitman, et al (2004), the intrinsic value of any investment equals the present value of the expected cash flows For a share, the intrinsic value

is the sum of the cash dividend received each year and the future price of the share Another way to view the cash flow benefits of a share is to assume that the dividends will be received over an infinite time From this perspective, the value of share is equal to the present value of all the future dividends expected to provide over an infinite time This approach, which believes that the value of a share is a function of its future dividends, is known as the dividend valuation model (DVM) The DVM can be expressed as the following equation:

P is the value of the share

D t is the dividend received at year t

r is the required rate of return

As the equation 2.1 shows, the value of a share is equal to the present of all future dividends or the expected cash benefits Therefore, any economic factor that

affects either the expected future cash flow (D t ) or required rate of return (r) in

turn influences the value of the share

2.2 Relationship between industrial production and stock price

Industrial production is commonly used as a proxy for the real economic activity When compared to previous year’s figure, it depicts how fast the economy

is growing or contracting In theory, industrial production increases during economic expansion and decreases during a recession A change in industrial production, therefore, would signal a change in the economy The productive capacity of an economy rises during economic growth, which contributes to the ability of corporations to generate more cash flows As mentioned above, since stock price is a function of future cash flows, changes in future cash flows will lead to changes in the prices of shares In short, any significant change in economic growth, even up or down, can affect the stock price through investor’s investment decision making For instance, if investors believe that the economy is growing and companies are making more profits along with economic growth, they will be willing to pay more for buying stocks, leading to an increase in the stock prices Conversely, if there is a decline in economic growth, they will be willing to sell the stocks or pay less for buying them, resulting in a fall in stock prices

Moreover, Wongbangpo and Sharma (2002) claim that a growth in output increases expected future cash inflows and profitability of enterprises that create a higher future dividend With the expectation of higher dividend, investors are always willing to buy shares at a higher price As a consequence, the share price will go up In contrast, the opposite outcome is likely to occur in a recession It means that the share price will fall when there is a decline in output because this

lowers the profitability of the company To sum up, theory suggests that there exists a positive association between stock price and industrial production

Many empirical studies use the industrial production index as a proxy for economic activity The growth of production may be consistent with the average growth of the company’s sales and its cash flows Therefore, industrial production index should be useful in the asset pricing model (Chen, et al., 1986) Furthermore, several empirical studies in emerging markets show the positive relationship between real economic activity and stock price In the most recently published research, El-Nader and Alraimony (2012) examine the relationship between Amman stock market return and Jordanian macroeconomic factors They use real gross domestic product (GDP) as a representative for real economic activity and point out that GDP has a positive effect on Amman stock price in Jordan

An additional study in a group of five Asian countries carried out by Wongbangpo and Sharma (2002) shows the similar result They point out that stock prices in all five Asian countries, namely Indonesia, Malaysia, Philippines, Singapore, and Thailand are positively related to growth in output, which is represented by gross national product (GNP)

Furthermore, and (2005) investigate the relationship between industrial production and stock prices in Istanbul stock exchange in Turkey between 1991 and 2000 They explore that industrial production has a positive impact on stock return, excluding the period which begins the 1994 financial crisis and ends with the beginning of the 1997 Asian crisis

In the case of Vietnam, Hussiney and Ngoc (2009) examine the relationship between industrial production and stock prices in Vietnam from 2001 to 2008 They find out that industrial production has a positive effect on Vietnamese stock prices Their finding is consistent with theoretical expectations as well the results

of previous studies

Based upon the theories and empirical findings drawn from previous studies, the following hypothesis is set:

H1 Industrial production has a positive impact on the stock price in Vietnam

2.3 Relationship between interest rate and stock price

According to the process of stock valuation, a discount rate, which is perceived by investors as a required rate of return, is first determined A chosen discount rate depends on two components namely the time value of money and the riskiness of the stock The time value of money is represented by the risk free rate,

Figure 2.1 VN-Index and Industrial Production Index

Source: HOSE and GSO

while the risk premium represents compensation for the riskiness of the stock One

of the common methods utilized to determine the required rate of return is the capital asset pricing model (CAPM)

Where:

R i: the required rate of return on investment i

R f : the risk-free rate of return, the return that can be earned on a risk-free investment

β i: beta coefficient, or index of non-diversifiable risk, for investment i

R m: the market return; the average return on all securities

Since interest rate is often used as a proxy for the risk free rate, if interest rate changes, the risk free rate will change as well In fact, changes in interest rates are expected to affect the discount rate in the same direction through their effect on the risk free rates (Mukherjee & Naka, 1995) As the equation 2.2 shows, an increase in risk free rate will lead the required rate of return to go up Based on the dividend valuation model (DVM) mentioned in the beginning of this chapter, if nothing else changes, there will be a decline in share prices due to the higher required rate of return Conversely, if interest rates fall and everything else remains constant, the share price will rise because of the lower required rate of return

Moreover, the interest rate is one of the most important factors affecting the behavior of investors on the stock market From the perspective of asset portfolio allocation, the increase in interest rate will lead to the rise in opportunity cost A rise in this opportunity cost will motivate investors to substitute equity share for other asset in their portfolios (Apergis & Eleftheriou, 2002) More specifically, Apergis and Eleftheriou assume that there are bonds and stocks in an investor’s portfolio They claim that the relationship between stock prices and interest rate affects investor’s portfolio With higher interest rates, investors would prefer bonds rather than stocks In that case, they are willing to buy bonds and sell stocks

As a result, the stock prices will decline In contrast, a decrease in interest rate leads to an increase in stock prices

In addition, the interest rate is also considered as the cost of capital, which

is the price paid for the utilization of money for a specific period of time Therefore, the interest rate will have an impact on corporate profitability, if the company uses lending money for their operations Any rise in interest rate may cause a decline in future corporate profitability because of the rise in interest expense The lower profits, the lower future cash inflows that will lead the company’s stock price to fall Besides, if the interest rate expenses increase to such

a level that the company faces the risk of insolvency, then the company may go bankrupt In that case, investors will require higher risk premium Consequently, the share price will decline further Furthermore, a rise in cost of capital has an impact on investors who use lending money to invest in stocks in the same way In

conclusion, the theories suggest that there is a negative relationship between stock prices and interest rates

Several previous empirical studies investigate the impact of interest rates on stock prices in developed markets as well as emerging markets In emerging markets such as Bangladesh, Uddin and Alam (2007) find out that interest rate has

a significant negative relationship with stock prices in this country Moreover, the most recent study in South Asian countries namely Pakistan, India, and Sri Lanka shows the similar result that interest rate has a negative and significant impact on the stock market in these countries (Aurangzeb, 2012)

However, by studying a group of Asian countries, Wongbangpo and Sharma (2002) report the mixed results regarding the relationship between interest rate and stock price They explore that a negative relationship between interest rates and stock prices is observed in Singapore, Philippines and Thailand, while a positive relation is observed in Malaysia and Indonesia

In the case of Vietnam, Hussianey and Ngoc (2009) utilize monthly data during a 9-year period from 2001 to 2008 to study this relationship They employ basic interest rates and government bond rates (ten years) as proxies for short term and long term interest rates, respectively and find out that the long-term and short-term interest rates do not affect the Vietnamese stock price at the same direction Specifically, their findings show a positive relation between short term interest rates and stock prices, while long term interest rates have a negative impact on stock prices

In summary, the theories suggest a negative relation between stock prices and interest rates However, empirical findings are mixed As mentioned above, Hussianey & Ngoc (2009) find out that the short term interest rate has a positive impact on stock price in Vietnam from 2001 to 2008 Based on this finding, this study also expects that this relationship does not change in the following period Additionally, as the figure 2.2 shows, the stock prices and interest rates seem to move in the same direction from 2008 to 2013 Therefore, this study proposes the the following hypothesis:

H2 Interest rate has a positive impact on the stock price in Vietnam

2.4 Relationship between inflation and stock price

Inflation is another factor commonly used in previous empirical studies to investigate the relationship between macroeconomic indicators and stock prices According to the Fisher effect, the real interest rate is equal to the nominal interest

Figure 2.2 VN-Index and Interest Rate

Source: HOSE and IFS

rate minus the expected inflation rate Therefore, inflation rate determines how much of real return of an investment will be lost when there is an increase in the inflation rate Moreover, inflation also affects the required rate of return, which investors need to compensate for an investment, by influencing the nominal interest rate Generally speaking, the inflation will affect the stock price in two ways The first way is through its impact on future real earnings and the second way is through the way that investors discount future earnings

By the first way, inflation reduces investments and therefore, economic growth and future earnings In fact, the inflation rate in an economy has a great impact on investor’s decision-making The investors are always faced with the decision of whether to make investments or not An increase in inflation rate can cause the real income to decline If this case happens, the investors will end up selling their financial assets, including stocks As a result, stock prices will fall In contrast, when the inflation rate is low, the investors would like to purchase more financial assets and stocks are not exclusive Regarding company, the impact of inflation on stock prices actually comes from its effect on a company’s earnings In the case of low inflation, the company can keep the cost down and increases the profits When the company makes more profits, investors are willing to buy stock

at a higher price

As regards the second way, inflation affects stock prices through discount factor According to CAPM, the discount factor consists of two components, namely the risk-free component and risk premium component When inflation

rises, the interest rate will go up This leads to the risk free rate, which is commonly represented by interest rate, will increase as well In the case of inflation leading to a higher discount rate, the present value of future earnings will

be declined and the stock prices are expected to fall as well (Malkiel, as cited in Apergis & Eleftheriou, 2002) In summary, theory suggests a negative relationship between inflation rates and stock prices

With respect to previous studies, Udegbunam and Eriki (2001) examine the effect on stock prices of inflation in Nigeria They use a simple stock price model, which includes as control variables, other key determinants of stock prices, and is specified and estimated by Ordinary Least Square method Their finding indicates that inflation through various channels such as discount rate, nominal contracts, and tax effects, has a significantly negative impact on the Nigerian stock market

In a recent study, El-Nader and Alraimony (2012) investigate this relationship in Jordan They find out a negative relationship between Amman stock index and inflation This finding is consistent with the results drawn from all five Asian countries, namely Thailand, Indonesia, Malaysia, Singapore, and Philppines (Wongbangpo & Sharma, 2002) and from Ghana (Coleman & Tettey, 2008)

Aurangzeb (2012) uses data collected during the period from 1997 to 2003

of three South Asian countries, namely Pakistan, India, and Sri Lanka to investigate the relation between macroeconomic indicators including inflation and stock prices The finding of this study indicates the insignificant negative impact

of inflation on stock market performance of these countries In conclusion, all

empirical findings and theories state that there is a negative relationship between inflation and stock price Following the results of previous studies and theories, this study, therefore, designs the following hypothesis:

H3 Inflation rate has a negative impact on the stock prices in Vietnam

2.5 Relationship between exchange rate and stock price

In previous studies, the exchange rate is also an important factor used to examine the impact of macroeconomic indicators on stock price since it influences the firm’s cash flow In fact, changes in exchange rates affect exported and imported firms conversely In case of depreciation of the local currency, exported products will become more attractive due to the cheaper price As a result, if demand for exports and imports is elastic, the volume of exported products will increase, which in turn causes higher cash flows, profits and stock price of the exported firms Simultaneously, a depreciation of domestic currency makes

Figure 2.3 VN-Index and CPI

Source: HOSE and IFS

imported products become more expensive, which in turn causes lower cash flows, profits and stock price of the imported firms Consequently, the stock price of imported firms decreases Therefore, in theory, the relationship between exchange rates and stock prices may be positive or negative

In addition, since there has been a considerable increase in economic globalization, all businesses are affected directly or indirectly from international activities As a result, changes in exchange rate influence both multinational firms

as well as domestic firms The effects on multinational firms are more direct, because a change in exchange rate will be reflected in foreign operations resulting

in a loss or a profit if the firm does not hedge This effect will change the value of the firm resulting in changes in the price of its stock

As regards foreign investors in the stock market, they not only focus on stock return, but also on the stability of the host currency when investing in foreign stock markets Because changes in exchange rate directly affect their investment decision-making For instance, a depreciation of host currency leads the value of shares, which foreign investors are holding to decline when they convert into their home currency If the return from stocks cannot compensate for the loss caused by depreciation of host currency, they will lose their money Therefore, they will sell stocks in order to preserve their capital if there is a large depreciation of host currency As a result, the stock price will fall as well

El-Nader and Alraimony (2012) also investigate the relationship between exchange rates and stock prices in Jordan They point out that exchange rate has a

negative impact on Amman stock market However, the finding of Aurangzeb (2012) for a group of South Asian countries namely Pakistan, India, and Sri Lanka indicates the opposite result Specifically, Aurangzeb (2012) states that there exists

a positive relation between exchange rates and stock prices in all these countries

Similarly, Wongbangpo and Sharma (2002) explore the mixed results They find out that the effect of exchange rates on stock prices in Indonesia, Malaysia, and the Philippines is positive Conversely, a negative relation between exchange rates and stock prices is found in Singapore and Thailand

Moreover, & (2005) investigate this relationship in Turkish stock exchange (Istanbul Stock Exchange) and conclude that while the depreciation of domestic currency leads to a decrease in stock returns before and during the financial crisis in 1994, the relationship turns out to be the opposite afterwards To sum up, empirical findings for the relationship between exchange rate and stock prices are mixed, meaning that it may be positive or negative Because Vietnam is still an importing countries, a depreciation of domestic currency makes imported products become more expensive, which in turn lowers the cash flows, profits and stock price of the imported firms Consequently, the stock price of imported firms decreases Therefore, this study believes that the exchange rate has a negative impact on Vietnamese stock prices and proposes the hypothesis as follows:

H4 Exchange rate has a negative impact on the stock prices in Vietnam

2.6 Hypotheses summary

After reviewing the theories as well as previous empirical studies, the

hypotheses regarding the relationship between stock prices and macroeconomic

factors are summarized as follows:

H1 Industrial production has a positive impact on the stock prices in Vietnam H2 Interest rate has a positive impact on the stock prices in Vietnam

H3 Inflation rate has a negative impact on the stock prices in Vietnam

H4 Exchange rate has a negative impact on the stock prices in Vietnam

0 5,000 10,000 15,000 20,000 25,000

Figure 2.4 VN-Index and Exchange Rate

Source: HOSE and IFS

2.7 Research model

Based on the results of previous studies and hypotheses that are mentioned above as well as the models adopted by Coleman and Tettey (2008) and Hussiney and Ngoc (2009), this study designs the research model as follows:

Figure 2.5 Conceptual model

CHAPTER 3: RESEARCH METHODOLOGY

This chapter mainly focuses on the methods applied to conduct the research

It includes five parts: the first part is the process of research; the second part is the measurement of variables; the third part is data collection; the fourth part is model specification; and the last part presents the methods used to analyze the data

3.1 Research process

Research process depicts steps need to be conducted in this study The research process in this study was designed as follows:

Figure 3.1 Research process

Research problem definition

Hypotheses formulation

Data analysis and Interpretation

Conclusions & Implications

Literature review Relevant theories Previous empirical studies

Research design

3.2 Measurement of variables

3.2.1 Dependent variable

Vietnamese stock prices are commonly represented by VN-Index (for Ho Chi Minh Stock Exchange HOSE) and HNX-Index (for Hanoi stock exchange HNX) Based on the capitalization scale, operating time and the number of listed companies as well as the number of investors, this study selected the monthly VN-Index as a proxy for Vietnamese stock price as well as a dependent variable for empirical work The monthly VN - Index was calculated by taking natural logarithm of the monthly closing price (Coleman & Tettey, 2008; Pal & Mittal, 2011)

3.2.2 Independent variables

Industrial production, interest rate, inflation rate, and exchange rate were used as proxies for independent variables of empirical work More specifically, industrial production was measured by the month-end industrial production index (Hussiney & Ngoc, 2009) Regarding interest rate, monthly lending rate was used

as a proxy for interest rate (Coleman & Tettey, 2008) With respect to inflation rate, it is measured by the month-end consumer price index compared to the corresponding period of previous year (El-Nader & Alraimony, 2012) As regards exchange rate, this variable was measured by monthly average exchange rate, which is the amounts of the domestic currency (VND) per unit of USD (El-Nader

& Alraimony, 2012) All independent variables were transformed by taking the natural logarithm (Coleman & Tettey, 2008; Pal & Mittal, 2011)

3.3 Data collection and sample size

There are two methods of data collection, namely primary data collection and secondary data collection Primary data are the data collected from the first-hand experience, which means these data have been not published yet and are more reliable On the other hand, secondary data are the data already published or used in any kinds of forms The review of literature in a research study is a kind of secondary data Moreover, journals, articles, and internet or public information sources are also secondary data

This study used the secondary data method In order to accomplish the research objectives, the time series of monthly data spanning from January 2008 to May 2013 were used Vietnamese stock prices (VN-Index) were collected from Ho Chi Minh Stock Exchange Data for industrial production were obtained from the General Statistic Office (GSO) of Vietnam Data for the remaining of variables (interest rates, CPI, exchange rates) were collected from the database of International Financial Statistics published by International Monetary Fund

Table 3.1 Description of variables

Industrial

production

Monthly index of

Interest rate Monthly lending interest

Inflation rate Monthly consumer price

Exchange

rate

Monthly exchange rate

3.4 Model specification

In order to undertake the empirical analysis of the relationship between the selected variables and the stock price index, this study applied the model introduced by Coleman and Tettey (2008) in their research work Therefore, the following empirical model was estimated:

Where, VNI t is stock price index; IP t is industrial production index; IR t is

lending interest rate; CPI t is consumer price index; EXR t is the exchange rate; β 1 ,

β 2 , β 3 , β 4 are the coefficients of variables and ɛt is the error term

In addition, this study took the natural logarithm of all variables in the equation 3.1 in order to be able to conduct a partial elasticity analysis (Coleman and Tettey, 2008), thus the impact of change in macroeconomic variables on the stock price index can be assessed, holding all other factors constant Therefore, the estimated equation was as follows:

3.5 Method of data analysis

This part of the study explained the methods applied to analyze the data for the purpose of this thesis This thesis followed the method introduced by Coleman

& Tettey (2008) in their research work Firstly, the unit root test or stationary test was applied to find out if the variables are stationary or non-stationary The reason for conducting the unit root test was due to the use of time series data The time

series data should be stationary in order to avoid getting spurious regression results (Gujarati, 2003) Next, if the time series variables are non-stationary at levels, but they become stationary at the same integrated of order (after taking differences), the cointegration test should be used to investigate the long-run relationship among them Finally, if the cointegration test shows that time series variables are cointegrated, the Vector Error Correction Model (VECM) is most efficient for representing the relationship among variables (Coleman & Tettey, 2008)

3.5.1 Unit root test

Unit root test is the most popular method used to test the stationary of time series data The time series data could be stationary or non-stationary According

to Gujarati (2003, p.797), the time series is said to be stationary if “its mean and variance are constant over time, the value of the covariance between the two time periods depends only on the distance or gap or lag between the two time periods”

In other words, it does not depend on “the actual time at which the covariance is computed” On the other hand, it is said to be non-stationary if its mean and variance change over time

Furthermore, the stationary of time series is so important Since if a time series is non-stationary, it can be only studied for a specific time period under consideration “Each set of time series data will therefore be for a particular episode” (Gujarati, 2003, p.798) Therefore, Gujarati states that it cannot be used

to generalize to other time periods As mentioned above, it is necessary to perform

a pretest in order to ensure there is a stationary cointegration relationship among variables to avoid the problem of spurious regression Therefore, all time series