The impact of macroeconomics environment on vietnam stock returns

In the literature, relations between economic variables have been researched to give explanations to those relations, specifically, the effects of macroeconomic variables such as industr

VIETNAM-NETHERLANDS PROGRAM FOR MASTER OF ARTS IN DEVELOPMENT ECONOMICS

THESIS THE IMPACT OF MACROECONOMIC

ENVIRONMENT ON VIETNAM STOCK

DECLARATION

This is to certify that this thesis entitled “The Impact of Macroeconomic environment on Vietnam stock return,” which is submitted by me in fulfillment of the requirements for the degree of Master of Art in Development Economic to the Vietnam – Netherland program Thesis constitutes with my work and good supervision Assoc, Prof Dr Nguyen Trong Hoai and acknowledgment that have been made in the text in all material used

HUYNH PHI LONG

ACKNOWLEGMENT

First of all, I would like to express my appreciation to my supervisor, Prof

Dr Nguyen Trong Hoai, for his invaluable advice and encouragement in during the time that I do my thesis I have been lucky to have a supervisor who care so much my thesis and answered to all my question Without his guidance, my thesis would not be finished

Second I would like to give my special thanks to Dr Pham Khanh Nam and

Dr Truong Dang Thuy for his valuable suggestion that help to complete my thesis

Third, I would like to give my appreciation to all the lecture at the Vietnam – Netherland programme for their knowledge of all the course, during the time

I studied at the programme

ABSTRACT

This paper estimates the impact of macroeconomic environment on Vietnam stock returns and drawing the conclusion of the impact of macro variables on stock market in order to offer some appropriate policies to improve stock market and provide investors of more information This study uses multiple regression analysis with monthly dataset for recent years from 01/2004 to 08/2013 to evaluate the relationship between macroeconomic factors and stock returns The model explains well the movement of stock return and shows that three variables (CPI, S&P500 and exchange rate) have significant effects on performance

TABLE OF CONTENT

Chapter 1 INTRODUCTION 1

1.1 Problem Statement 1

1.2 Research Objectives 3

1.3 Research Questions 4

1.4 Research scope and data 4

1.5 Thesis structure 4

Chapter 2 LITERATURE REVIEW 5

2.1 Endogenous growth theory 5

2.2 Empirical studies 7

2.3 The results of testing the influence of macroeconomic factors on world stock markets 9

2.3.1 An overview of the relationship between stock and macro factors in each country 9

2.3.2 Evidence from U.S stock market 11

2.3.3 Evidence from stock markets: Brazil, India, China, Russia 11

2.3.4 Empirical evidence in Thailand 12

2.3.5 Evidence from stock market in London 13

2.4 Research Hypotheses 15

2.4.1 The impacts of Industry production on stock return 15

2.4.2 The impact of inflation on stock return 16

2.4.3 The impact of interest rate on stock return 17

2.4.4 The impact of exchange rate on stock return 18

2.4.5 The impact of oil price on stock return 21

2.4.6 The impact of gold price on stock return 22

2.4.7 The impact of different stock markets on each other 23

2.5 Conceptual framework 25

Chapter 3 RESEARCH METHODOLOGY 28

3.1 Data source 28

3.2 Methodology 30

Chapter 4 RESEARCH RESULTS 32

4.1 Bivariable analysis 32

4.1.1.The impacts of Industry production on stock market 32

4.1.2 The impact of inflation on stock market 33

4.1.3 The impact of interest rate on stock market 35

4.1.4 The impact of exchange rate on stock market 36

4.1.5 The impact of oil price on stock market 37

4.1.6 The impact of gold price on stock market 38

4.1.7 The impact of different stock markets on each other 39

4.2 Analyzing the return of investment (ROI) of VN-index by the multivariate model 41

4.2.1 Correlation matrix 41

4.2.2 The multivariate model 44

Chapter 5 CONCLUTION 47

5.1 Summary of results 47

5.2 Policy recommendation 49

5.3 Limitation of the study 50

REFERENCES 52

APPENDIX 58

SOURCE OF DATA 68

LIST OF TABLE

Table 2.1 Conceptual framwork 25

Table 3.1 The expected sign of variable in model 28

Table 3.2 The correlation on the sample observations 41

Table 3.3 The result of regression model 42

LIST OF FIGURE

Figure 3.1 The proportion of the value of good in Viet nam 32

Figure 3.2 VN index and Industrial production 33

Figure 3.3 VN index and Inflation 35

Figure 3.4 VN-Index and interest rate 36

Figure 3.5 Vn index and exchange rate 37

Figure 3.6 Vn index and Oil price 38

Figure 3.7 Vn index and Gold price 39

Figure 3.8 Vn index and S&P 500 40

Chapter 1 INTRODUCTION CHAPTER 1: INTRODUCTION

1.1 Problem Statement

Pramod K Complaints and Puja Vidhi (2012) showed that stock market has an indirect impact on the developing by playing a crucial role in its two primary components: industry and commerce Therefore, in the investors view, the stock market also occupy an important position Securities is reputedly a source of long – term capital In consequences, investors could supply capital to companies which are in case of need through the stock market In another word, securities allow companies to expand their business as well as provide a surplus fund to the capital market Before investing in securities, investors should have a thorough grasp of the market by observing the fluctuation of different index Analysing the various indicators is an effective method to have a comprehensive view of the stock market Then, investors can forecast the trend of stock market in the future, make up efficient portfolio to gain the highest profit

The efficient market hypothesis proposed by Fama (1970) placed a very significant economic theory for policy makers and investors Accordingly, policy makers are free to implement global policies without worrying about changing the essence of stock market, since they only change the share prices Also, economic theory hypothesizes that stock price reflects not only the available information but also the expectation of firms’ future operation

If stock price can accurately reflect the macro environment, it can also be used to be an indicator of future global conditions Therefore, studying the causality and mutual interactions between macro variables and stock price is of great important when the Government is considering any policies for the nation

In the literature, relations between economic variables have been researched to give explanations to those relations, specifically, the effects of macroeconomic variables such as industry production, money supply, inflation, exchange rate, gold price, etc., on the stock price, and the relation between those macro variables In Vietnam, changes in global policies and macro variables are often occurring abruptly, leading to strong effects, which are both

negative and positive, to investors’ sentiment By applying econometric models, we may have the more general view of the risks and volatility of VN index, generating forecasts and cautionary for investment activities That research are based on econometric tests with highly reliable data and general view of the yield on Vietnam stock market

However, many research has proceeded for the stock market and economic factors, and, therefore the conclusions may not be enough As a result, it has been argued that the risk factors from the local rather than risk factors from the world are the primary cause of variation in the stock market According to Hooper, Brailsford, and Bilson (1999) solve the problem of macroeconomic variables that can derive from sources of local risks Sims and Maysami have used Error Correction Modelling techniques to check the relationship between macroeconomic variables and profit shares in Hong Kong and Singapore ( Koon., Wee and Maysami (2004)) Through the Koon., Wee and Maysami (2004), their methods had facilitated to infer relationships between the variables short-term macroeconomic adjustment and balanced long-term, they analyzed the impact of interest rates and inflation, money supply, exchange rates and fluctuations, in fact, with a dummy variable to capture the effects of the Asian financial crisis in 1997 The results can be verified that the impact of macroeconomic variables on the stock market index in each of the six countries being studied, although the type and size of different associations depending on the financial structure of each country Raman K Agrawalla (2010) attempts to find whether the economic factor can reflect stock price The relations of some macroeconomic factors may change from markets to markets; may vary during various form and also at different frequencies of data Therefore, much intensive research necessary for understanding the macroeconomic variables that can affect the stock market Moreover, the capital markets have experienced significant changes when to apply the policy liberalization, and it became more open to international investor The reform of market and potential economic had attracted a large number of foreign institutional investors in the stock exchange

Vietnam stock market opened on 28 July 2000 with only two stocks, and now in 2013, it has over 700 stocks with the market cap of about VND 964000 billion, equivalent to 31% of GDP Since inception, Vietnam stock market has benefited the economy

Firstly, when investors buy shares, they contribute their money to the company’s business The Government and local authority also raise fund to invest and develop economic infrastructure

Secondly, stock market offers investors a healthy investment environment with a lot of investment options, and this is a new investment channel with high liquidity, apart from the traditional ones such as gold, forex, and real estates

Thirdly, stock market helps to improve the transparency of companies’ business, providing an ambitious investment scheme, hence improving the capital efficiency, giving companies incentive to apply new technologies

Fourthly, the stock market index reflects the economy promptly on time and accurately Stock price increasing implies investment expansion and a growing economy, and vice versa Therefore, the stock market is seen as an indicator of the economy and an important channel for the Government to implement macroeconomic policy

In the past few years, the world economy has experienced several critical period and facing challenges such as recession, inflation, unemployment Vietnam is not an exception, as it also has troubles with high inflation, budget deficit, high sovereign debt, fluctuated exchange rate… These effects are not only on the economy but also on the stock market Therefore, studying the impacts of macro variables on the stock market is crucial The paper aims to provide new evident for investors and companies as well as policy makers about the role of macro variables before they participate in the stock exchange as well as design appropriate policies related to stcok market in Vietnam

1.2 Research Objectives

1 Determining the impact of macroeconomic environment on Vietnam stock returns

2 Drawing the conclusion of the impact of macro variables on stock market in order

to offer some appropriate policies to improve stock market activity and provide investors of more information

1.3 Research Questions

There are two keys research questions to be answered as below:

1 Can internal macro variables such as inflation, exchange rate, oil price explain stock return?

2 Can external variables such as the US stock market affect stock price?

1.4 Research scope and data

This study tests the impact of macroeconomic environment on Vietnam stock returns From the findings of this paper, this study uses multiple regression with monthly dataset for recent years from 01/2004 to 08/2013 to test the relationship between stock returns and macroeconomic variables (industry production, inflation, interest rate, exchange rate, oil price, gold price, different stock markets)

1.5 Structure of the Thesis

The paper contain four chapters: chapter 2 introduces theoretical and empirical studies about the impact of macroeconomic factors (industry production, inflation, interest rate, exchange rate, oil price, gold price, different stock markets) on Vietnam stock return Chapter 3 presents regression model and key variables that is used in this paper Chapter 4 provides an overview about the impact of macroeconomic environment on Vietnam stock returns Moreover, the descriptive statistics of the sample are also refered in this chapter Concurrently, analyzing and discussing the regression results are also mentioned in this part Chapter 5 summarizes analyses and results from the previous parts to propose recommendations and related policies as well as the limitations of this study

CHAPTER 2: LITERATURE REVIEW

This chapter introduces four main parts The first part reviews theoretical backgrounds about the stock return The second part provides some empirical studies in the Vietnam and the world Third part summarizes some of the results of testing the macroeconomic impacts on stock return The last part is research hypotheses and analytical framework

2.1 Endogenous growth theory

None of the good theories assert that the relationship between financial market and macroeconomic factors entirely is only in one direction However, the stock price is often considered the reaction to the external effects (even they also impact on other variables) Obviously, all the economic variables are endogenous ones in the key judgments Only natural agents such as meteors, earthquakes, or anything like that, are truly exogenous variables for the world economy The purpose of Chen, Roll and A.Ross (1986) is simply to set up capital stock the rate of return model as functions of economic variables and the rate

of return of non-capital assets (debt) Thus, the study of Chen, Roll and A.Ross (1986) have seen the stock market as endogenous variables and related to other markets

As the debate on hide function diversification in theories of capital markets, only the basic economic variables affect the price of most stock markets prices Any system variables affect the pricing decisions of the economy or affect dividend, then also affect the rate of return on the stock exchange Moreover, the variables needed for the description of government will also be part of the description of the systematic risk factors For example, such a variable will not directly impact on current cash flow but will reflect changes in the investment opportunities

Stock price is often calculated by expected dividend discounted at present:

Here, p is stock fair value, c is dividend stream and k is discount rate, This leads to real the rate of return on the stock market in the calculated periods

The expected cash flow changes because of both real and nominal factors The changes in the expected inflation rate will affect the expected nominal cash flow as well as nominal interest rate These abnormal fluctuations in prices will have a system impact on the scope of the evaluation in a real period And they also have changes in asset values associated with changes in average inflation rate on the extent that the relative price changes with overall inflation Finally, changes in the level of expected real production will impact on the net present value of cash flows The changes in the rate of production activity may affect the rate

of return on the stock market to the extent that the risk premium cannot calculate the volatility of industrial production through its effect on cash flow

According to Chen, Roll and A.Ross (1986), individual stocks depends on expected and unexpected elements They believe that most of the profit received from stock is the result of unforeseen factors and these factors related to the standard conditions of the economy In

reality, despite the interests of assets may also be affected by the impact that do not relate to the economy, profit from the large portfolio often take the main risk from systemic risk

2.2 Empirical studies

2.2.1 World studies

Through article by Hendry (1986), his approach has allowed inferences to short-term relationships between macroeconomics variables as well as the adjustment of balance in the long term, they have classified effects of money supply, inflation, exchange rates, interest rates and practical activities, with a dummy variable to capture the influence of the Asian financial recession in 1997 The obtained results confirmed the effect of macroeconomics variables on the stock market index in each country studied, although the type and size of various associations depending on financial configuration structure of each country

Islam (2003) studied the relations in the short and long-term balance between the stock return and interest rates four macroeconomics variables: inflation rates, interest rates, industrial productivity and exchange rates at Malaysia stock market The conclusion of is the same: there are statistically exist in short and long-term equilibrium relationship between macroeconomics variables and stock returns in the Malaysia stock market

The article by Ibrahim (1999) also examined the relationship between the Kuala Lumpur stock exchange Composite Index and seven macroeconomics variables includes: M1 and M2 money supply, projected foreign currency reserves, consumer price index, credit institutions, industrial production index and foreign exchange rates Observe macroeconomics variables leading the Kuala Lumpur stock exchange Composite Index, he concluded that the Malaysia stock market is asymmetric information

Findings of Chong and Koh (2003) are similar: they have shown that stock prices, economic activity, the real interest rate and balance balances in Malaysia to link together in the long term

Mukherjee and Naka (1995) apply error correction vector model of Johansen (1998) to analyze the relationship between the Japanese stock market and inflation, exchange rates, actual economic activity, money supply and rate government bonds in the long term They concluded that a real relationship between these factors and the stock price Simultaneously, Maysami and Koh (2000) also examined the relationship between the stock price and the factors on the stock market in Singapore They found that the relative growth in the money supply, inflation, changes in short and long-term interest rates and the exchange rate had an impact on the change in stock price on the Singapore stock market

Watanapalachaikul and Islam (2003) shows that close relationship between the price of long-term securities and macro factors: the price of bonds, capital markets, consumer price index, exchange rate and interest productivity in Thailand during 1992 to 2001 Article by Omran (2003) studied the impact of the actual rates as an important factor in the operation of the Egyptian stock market, both in terms of market activity and liquidity

Phan Thi Bich Nguyet and Pham Phuong Thao Duong (2013) had mentioned having mentioned empirical studies about the impact of macroeconomic factors on the stock market, the results of research on this topic have many differences in each market After forming

stage and operation, Vietnam stock market had made a tremendous contribution to Vietnam economy However, the stock market is still many inconstant and potential risks The up and down of the Vietnam stock market in recent years due to many different factors that can not exclude the impact of macroeconomic factors

Phan Thi Bich Nguyet and Pham Phuong Thao Duong (2013) based on Arbitrage Pricing Theory (ATP) by Chen, Roll, Ross (1976) to explain the rate of return on the stock market APT theory assumed that the expected profitability of securities is determined by the equation k factors: Rj = αj + βj,1F2 + … + βj,kFk + up The APT factors in the model may

be macroeconomic factors or macroeconomic factors According to the research, variables affecting stock market include industrial production, consumer price index (CPI), money supply, GDP, exchange rates, interest rates, inflation, political risk oil prices, trade area, and the other stock markets

The research aimed at testing for considering whether there are relationships between the macroeconomic factors and the stock market The research results showed that the variables: money supply, inflation, industrial output (representing real economic activity), world oil prices were a positive correlation with the stock market while the interest rate and exchange rate between VND/USD show the negative correlation with the stock exchange By these findings, the authors suggest policy implications for macroeconomic management and the market with the aim to develop a professional stock market

2.3 The results of testing the influence of macroeconomic factors on

world stock markets

2.3.1 An overview of the relationship between stock return and macro factors in each country

One of the earliest studies giving us convincing evidence about the behavior of securities prices with macro variables for emerging markets is conducted by Kwon, Shin and Bacon (1997) for the Korean market from Jan1980 to Dec1992 The independent variables include index of industrial production, inflation, expected inflation, risk premium, term structure,

dividends, trade balance, exchange rates, oil prices and money supply All these variables will be regressed on monthly data series of the stock price-weighted index Research results indicate that the stock market in Korea is more sensitive to the real economy and international trade than in the United States and Japan That is expressed through the exchange rate, trade balance, money supply and industrial production index

The most general study of the relationship between stock and macro factors is built by Muradoglu, Taskin, and Bigan (2000) Muradoglu and colleagues examined the relationship between the rate of return of 19 emerging markets: exchange rate, interest rates, inflation and industrial production from 1976 to 1997 As a result, the relationship between the rate of return on the stock market and macroeconomic variables depends on the size of each market and its contribution to the international market In the study on the relationship between the Greek stock market with 18 macroeconomic variables in the period from 1980 and 1992, Diacogiannis and colleagues have found strong relationships between the rate of return on the stock market with 13 of the 19 variables that they examined in the two periods, 1980-

1986 and 1986-1992 Wongbangpo and Sharma discovered the relationship between the rate

of return on the stock market with five macro variables in five ASEAN countries were Indonesia, Malaysia, Philippines, Singapore, and Thailand By observing the relationship in both the short and long term of each security index and variables as GNP, CPI, money supply, interest rates, and exchange rates, as a result, in long-term, all five indexes have the definite relationship between output growth and the current price

In the long term, although the relationship between the market rate and interest rate is not reflected clearly in markets such as Philippines, Singapore, and Thailand, it is fairly clear in markets such as Indonesia and Malaysia Finally, the correlation testing leads to an overall result that there exists the relationship between the market and macro variables for these five ASEAN markets After all, Mukhopadhyay and Sarkar establish a the rate of return on the stock exchange system analysis for Indian market before and after the liberalization of markets and the impact of macroeconomic factors on the rate of return on the stock exchange Specifically, after liberalization period (since 1995), economic activity, inflation,

money supply growth, FDI, and NASDAQ index are significant in explaining the rate of return on the stock market in the Indian market While during the period before liberalizing (1989 -1995), the nominal exchange rate makes sense but after a period of liberalization yet

2.3.2 Evidence from U.S stock market

One of the popular papers of the multi-factor model is the study "Economic forces and the stock market" by Chen - Roll - Ross wrote in 1986 To illustrate the various effects of macroeconomic variables in the stock exchange, the research is done through testing in the U.S market This study considered seven factors include: changes in industrial production, risk premium, term structure, inflation, the rate of return on the stock exchange, actual spending and oil prices Data are collected monthly from Jan 1953 to Nov 1984 Results showed that some economic variables are proved to be significant in explaining expectations the rate of return on the stock market, especially industrial production, changes in the risk premium, the yield curve, and a few weaker variables as the extraordinary inflation measure and changes in expected inflation during high volatility periods The author has also tested the effect on the valuation of securities changes in real per capita consumption and oil price index changes But the results show that there is not a full impact

Results also showed that the rate of return on the stock market is expressed through the commercial information system, their risk prices them, and the information can be measured

as the change in the variables that I can get the pure financial theory and intuition

2.3.3 Evidence from stock markets: Brazil, India, China, Russia

In the paper, "Effect of Macroeconomic variables on stock market returns for four Emerging economies: Brazil, Russia, India and China" done by Robert D Gay (2008), he conducted testing the effects of macroeconomic factors on the stock market using the Box - Jenkins method - ARIMA model To describe this relationship, the author used the one month average MA, three months, six months and 12 months for the latency of a stock price dependent Variable and exchange rate, oil price variables Data are collected monthly from March 1999 to June 2006 for four countries: Brazil, Russia, India, and China

The analysis results show that there is the same direction relationship between price rate and stock price in the markets: Brazil, Russia, and China This means that high (low) currency pricing compared to the U.S dollar will have negative (positive) impacts on the domestic stock market A rise in oil prices will negatively impact on the stock exchange Analyzing the impact of international macroeconomic factors such as exchange rates and oil prices in equity markets of China, Brazil, India and Russia does not show a clear relationship This is based on the parameter values of the independent variables and the corresponding p-value,

along with the parameter R2 for each model

2.3.4 Empirical evidence in Thailand

The study "Economic Forces and the Thai Stock Market" done by Komain Jiranyakul (2007), explained the relationship between stock price index and macroeconomic variables in Thailand Data was collected quarterly from the first quarter of 1993 to the fourth quarter of

2007

Testing results showed that the variables are associated with each other, and have a term relationship between the stock price index and four macroeconomic variables: real GDP, money supply, nominal exchange rate and inflation Especially, the financial crisis in

long-1997 is without impacts on security price The results of the testing (the model error correction) showed the relationship between TSSL of the stock market with growth rates in the short and long term Real GDP, nominal exchange rate, money supply have an impact on the price of securities in the same direction while inflation has an adverse effect on securities prices

To establish a long-term relationship between the variables in the model, the author finds the reason in the short term and long term of the fundamental difference between the variables

As a result, based on theory Granger, that shows that there exist a link between the variables Besides, the author also predicted coefficients in ECT (error correction term) These factors represent adjustments in long-term while the short-term boom is described by the delay price coefficients of the fundamental difference The results showed that stock price and real GDP

in the long-term

2.3.5 Evidence from stock market in London

The objective of the study "The Effects of Macroeconomic Factors on the London stock returns: A Sectoral Approach” of authors Nil Giinsel & Sadik Cukur (2007) is to analyze APT applications to price stock in the UK, and to determine the macro variables that best suit the market factor The research is developed into 7 macro variables, including term structure of interest rates, unexpected inflation, industrial production, risk premium, money supply (M0), and unexpected dividend rate and considering the impact of these variables on the food industry, drinking water, and tobacco; construction; building materials and trade, electrical and electronic equipment; Mechanical Engineering; Household, goods and textiles; Manufacture of paper, packaging and printing; Chemicals; Diverse industries; And mining and oil production Observed sample includes companies being available in the data stream from January 1980 to December 1993

The regression results showed major differences of industry category compared to macro variables R2 ranges from 28 % - 94 % The reason is that the use of variables such as industrial production sectors unexpected dividend rate Test results also show the significance level of 1 %, the coefficient of the dividend yield is negative for all sectors This

is not too surprising because the price of securities is determined by the expected dividend stream in the future However, it is expected to be positive Results being contrary to expectation can be explained based on the practical theory This means that investors will forecast dividend flow before being noticed In this case, it seems that investors expect a dividend level being very different from reality This may be due to unexpected dividend yield The authors use the unchanged modeling expectation to find the variable On the market, investors use many different tools to predict profit as accounting data, expectations about industry or economy

Unexpected inflation has not any effects on TSSL sector, excepting for food, drinks and tobacco affected about 10 % according to the inspection results This means that the market reflects the inflation numbers approximately compared to the real inflation rate.Risk premium has the same direction impact with TSSL of construction and engineering

However the industry has some similar characteristics, we cannot conclude that the risk premium has the same direction impact on all industries because the risk premium for one month shows the opposite effects

Although effective exchange rate is a critical factor, it does not mean it will affect the yielding of an industry That's because businesses often use tools like derivatives to hedge exchange rate So, it would not be too surprised if we do not find any relationships between the exchange rate in effect and yielding of an industry Results mention two areas: building material impacts the same direction with the profit rate of the construction materials industry and commerce; food, drinks and tobacco; and have the adverse effect on the rate of return of household goods and textiles

Term structure of interest rates with one month delay has an impact in the same direction with a profit rate of four sectors: Construction, food, drinks and tobacco; mining and petroleum processing; electrical and electronic equipment Based on the testing results, we can see the interest rates in short-term could have an impact on the same direction with the construction industry; food, drinks and tobacco, mining and oil and gas processing Especially, electronics industry because the electronics industry requires high fixed capital investment and the long-term capital recovery

Calculations of industrial output show a different relationship with food, drinks and tobacco industry at the 5% significance level Industrial production with three-month latency also shows a negative effect of this variable on the paper industry, packaging, and printing with a significance level of 1% Similarly, with a significance level of 1%, industrial production also has opposite effects in engineering However, at a significance level of 5%, industrial production with one-month latency has an impact in the same direction with household goods and textiles

2.4 Research Hypotheses

2.4.1 The impacts of Industry production on stock return:

George Filis (2009) states that industry production always induce moves along with economic cycle, i.e., it increases in recovery and successful session, a drops in recession It is usually used as a measure of economic activities An increase in industry production anticipates an economic growth John K M Kuwornu (2011), Sezgin Acikalin, Rafet Aktas and Rafet Aktas (2008) show the positive relation between industry production and future expected cash flows

The production capacity of the economic depends strictly on the procedure of real assets accumulation, which contributes to the companies’ ability to create cash flows Peter Young (2006)’s discovery, based on a portfolio of US stocks, shows that future increase of industry production help to explain stock return and the relation is positive The potential explanation

is increased industrial production leads to increase in economic activity resulting in higher earning for companies The potential higher earnings should result in rising in stock valuations resulting in stock gains In a research of Harrison Hong, Walter Torous and Rossen Valkanov (2007), he also finds the definite relation between the growth of industry production and stock return Kewei Hou and David T Robinson (2006) have contributed some endogenous growth models under which macroeconomic environment could affect stock returns

The rate of growth of industrial output is tested because the stock market has a relationship with changes in industrial activities in the long term Share price includes the value of future cash flows, and a growing economy will increase the ability to generate the cash flow of the company in the economy thereby increasing share prices and increasing the rate of return on the stock market The rate of return of stock monthly cannot be highly correlated with seasonal changes in industrial output However, these changes may contain relevant information for pricing The monthly changes in securities prices reflect the change of expected industrial production in the future

It is hypothesized that there is a positive relationship between growth of industrial production and stock return

2.4.2 The impact of inflation on stock return

Research of Paolo Giordani and Paul Soderlind (2002), Geert Bekaert and Eric Engstrom (2008), A.Ang, Monika Piazzesi and M.Wei (2006) impress the negative relation between inflation and stock price The stock market is likely to boom under the two conditions: high economic growth and low inflation As such, a growing economy associating with high inflation is not necessarily ideal When inflation becomes a threat, investment analysts may doubt the prosperity of economy and reports showing any increase in the employment rate They fear that there is a high inflation caused by expansion of credit as a result of the Government growing budget deficit and expanding monetary supply

The relationship between inflation and stock prices is controversial, and it will change over time Empirical evidence from developed countries shows that the relationship is negative because inflation determines the root of growing High inflation is a sign of the overheated economy, indicating an unstable economic growth while stock market acts as the indicator of economic health When inflation raises, purchasing power of currency shrinks, investors tend

to hold cash less They instead invest in gold, real estate, foreign currencies… leading to a shortage of capital which is supposed to be invested in regular business such as manufacturing The growth of companies, and hence the whole economy will be slow down High inflation also affects business in the sense that even profitable companies with high dividend may not be attractive as real investment return is diminished, making stock investment no longer an unusual channel In a book that review the inflation and US stock market during a long period from 1929 to 1981, Stephen Leeb states that inflation is the foe

of the stock market

Increasing inflation is understood to cause an adverse impact on the rate of return on the stock market Because inflation is often accompanied by input prices of most businesses such

as borrowing cost, the cost of sales, the cost of production which are increasing But

companies can not immediately increase output prices thus the profitability of the enterprise will be reduced, this leads to stock price reduction

Increasing inflation also has adverse effects like: Increasing in selling distressed securities to withdraw capital from the stock market and increasing in buying real securities for "hidden" inflation This sell-off trend often occurs when the market has a lot of low-quality securities,

or the confidence of investors in the market is weak

It is hypothesized that there is a negative relationship between inflation and stock return

2.4.3 The impact of interest rate on stock return

Based on the evidence surveyed by Graham and Harvey (2001), interest rate risk is considered as a second important risk, the first is the market risk Graham and Harvey said that the interest rate volatility not only affects the company's expectations of future cash flows but affect the discount rate to assess the cash flows and the value of the enterprise The effect of interest rate on the market value of the firm has always received a lot of attention of economists However, changes in interest rates can have a significant impact on non-financial companies, mainly through their effect on the financial costs and the value of financial assets and liabilities organized by these groups (Bartram, 2002)

Krishnamurthy and Jorgensen (2011) prove that a change in interest rate, no matter whether

it is of long term or short term, of Interest rate affects the minimal risk-free rate, therefore, affects the discount rate and stock price Fama and Schwert (1997) observe the relation between stock price and a lag value of interest rate Reily and Brown (2011) make a more sophisticated statement that capital flow into stock market may change upon interest rate and that there is no certainty of whether the inflow will increase or decrease in response to a particular movement in the interest rate Recent papers examining the relation between interest rate and stock market show no definite answer

The rise in the money supply leads to restructuring the portfolio investment shifting to real property This increases the pressure on securities prices Therefore, the rate of return on the stock market reflects the changes in the nominal money supply unexpectedly In theory,

there are two different viewpoints about the impact of money supply on the stock exchange The first point of view (led by Fama, 1981) suggests that nominal money supply growth is correlated with inflation in the same direction, that inflation rates have an inverse correlation with stock price So, increasing money supply will be an inverse correlation with stock prices The 2nd one (pioneered by Jafee and Homa, 1971) says that increasing supply leads that real interest rates reduce This makes the stock price increase the effective rate decreased

to comb it will have an impact on share price increases Firstly, it reduces the discount rate used to discount the future cash flows in the valuation of securities Secondly, when the cost

of capital using is cheaper, companies have the opportunity to increase investment, thereby creating a higher future income

As analyzed above, an increase in interest rates is understood as one of the factors making the cost of corporate sponsorship increase But now enterprises are less likely to increase output prices correspondingly to compensate for the rise in input prices Thus, business income may decrease thereby reducing stock prices Higher interest rates also reduce the attractiveness of investment securities because borrowing costs for investment securities increase, investors tend to look for channel having the rate of return on the stock market higher and acceptable risk

It is hypothesized that there is negative relationship between interest rate and stock return

2.4.4 The impact of exchange rate on stock return

Dimitrova (2005) stated that exchange rate movement affects balance sheet items representing exchange currency relating transaction, and eventually affects profit and stock price Economists have examined the relation between stock price and the exchange rate for three decades However, different conclusions were made and in some cases, the results were not reliable Whether the relation between stock return and the exchange rate is negative or positive depends on whether the country has a net advantage to export or import Dimitrova (2005) stated that there is a link between the stock market and exchange rates that might explain fluctuations in either market In the short term, the trend in stock market prices may cause currency devaluation while weak currency could cause a decline in stock price

From the perspective of Dimitrova (2005), considering the relationship between stock prices and foreign exchange rates is necessary for some reasons The first, it may influence decisions regarding fiscal policy and monetary policy Gavin (1989) shows a strong stock market will have a positive impact on total demand Sometimes policy makers favor less valuable currency to promote the export sector They should know whether such a policy could undermine the stock market The second, the connection between two markets can be used to find out the change in foreign exchange rates This will be beneficial for multinational corporations to manage the release of international contracts and to avoid exchange rate risks The third, the currency will often be seen as an asset in the investment fund Finally, understanding of the relationship between foreign exchange rates and stock prices to predict a crisis may occur in the future

Khalid and Kawai (2003) suggest that the connection between the stock market and the currency has helped to spread the Asian financial crisis in 1997 According to Khalid and Kawai, the author said that the sharp devaluation of the Thai baht caused the depreciation of other currencies in the region, as well as lead to the collapse of the stock market

Research of Phan Thi Bich Nguyet and Pham Phuong Thao Duong (2013) had mentioned the exchange rate was negatively correlated with Vietnam stock market: when the exchange rate (USD depreciation) raised 100 VND/USD, the index VN-Index declined 16.6 points Vietnam is regular a trade deficit country because Vietnam always imports machines, the raw material from abroad US Dollar has been commonly used in Vietnam, the price of many products has been rated at the dollar, many companies in Vietnam prefer loan in US dollar than Vietnam Dongs, people have psychological hold dollars as a form of shelter to avoid risks The above has led when the exchange rate rise, VN Dong devaluation has created anxiety for investors It can be considered there is also a signal that many instability macroeconomics will come, so Vietnam stock market is declined

Knowledge of factors impacting stock price and exchange rate consume a lot of effort of economists, policy makers and investors for a long time In this globalized economy, barriers

to capital flow are limited, giving more investment opportunities to multi-national groups

Companies have exposure to 3 different kinds of risk: sensitivity to the economy, sensitivity

to the exchange rate and sensitivity of the economy to exchange rate This requires a deep understanding of the relation between exchange rate and stock price to hedge the exchange rate risk

The exchange rate between two currencies shows the relative relationship between the currency of a country with certain foreign currencies Specifically in this essay, this is the conversion rate between Vietnam dong and U.S dollar Along with the internationalization process, all business activities are directly or indirectly affected by international activities In other words, changing foreign exchange rates will affect the competitive position of the company and therefore, cash flows will changes The exchange rate can impact on the rate of return on the stock market on two different aspects

First, the exchange rate effects on the competitiveness of firms in the economy, in particular, the import-export business are greatest affected by fluctuations in the exchange rate, which influences the revenue and profit of the company If the currency is undervalued compared to foreign currency, it means that goods export prices of countries become cheaper than foreign goods, which increases the competitiveness of the exporters and increases cash flow for this company So, it makes the stock price increase While prices of imported goods will become more expensive, which means that the input cost of the importers increases, the merchants lose competitiveness, and their income will decrease So, it leads that share price of this company falls In contrast, in the case if the currency is overvalued compared to the main foreign exchange, the stock price of the exporting companies will fall due to loss of competitiveness in international markets during the share price of the exporting company increases due to input cost savings Thus, the impact of changes in exchange rates on the stock market depends greatly on the relative advantages of the export and import sector in the economy

Second, the exchange rate can affect the rate of return on the stock market through its impact

on shifting indirect investment flows to each country's stock market If the domestic currency

is expected to appreciate against the major currencies, the market will become more

attractive to foreign investors This can lead to an increase in stock demand and enable stock price to increase Currency devaluation concern would make foreign investors withdraw from the market, the stock selling pressure to withdraw capital securities may decline in the country's equity markets

It is hypothesized that there is negative relationship between exchange rate and stock return

2.4.5 The impact of oil price on stock return

The effects of the crude oil market in recent times has been reignited concern study the relationship between oil prices and stock prices Jones and Kaul (1996) studied the changes

in oil prices affecting the world stock market by using the quarterly data The study focused

on profit shares from the United States, Canada, United Kingdom, Japan, and the results show that the profit share for all countries (except the UK) were negatively affected by oil price

Sadorsky (1999) studied the relationship between oil prices and the United States stock returns by using the monthly data from January 1947 to April 1996 His results confirmed that there is a negative relationship in the short term between oil price and stock return, which means that stock prices will fall when oil price is higher

Research of Phan Thi Bich Nguyet and Pham Phuong Thao Duong (2013) had mentioned mentions world oil prices has a positive correlation with Vietnam stock market: When oil prices rose 1 USD/barrel, the VN-Index increased 4.4 points In theory, the relationship between the stock market and oil prices can be positive or negative The relationship can be active between oil prices to stock prices in the oil-exporting countries, but there is a negative for the oil importing countries Vietnam is not an exporting oil country, but there is a positive correlation between the stock market and oil prices, because due to intrinsic fluctuations in oil prices when the market shows Vietnam suffer interference from the Government, the signal is coming from this factor has been distorted

Hamiltion (2008) shows evidence that increase in oil price was the primary reason for almost all the recession after world war II Several papers tests the relation between oil price and the economy

Samuel Imarhiagbe (2010) stated that oil price affects stock return First, oil price is an input

of the manufacturing process Stock prices would fall when input costs rise Second, as explained by Huang, Masulis and Stoll (1996), expected oil price impacts inflation and interest rate For an oil net import nation, an increase in oil price will increase inflation, raising the discount rate, making the stock price to fall Third, when oil price is not stable, new strategy on energy is offered In the period of oil shortage, investors consider investment

in oil, both direct and indirect, as a hedge for the stock market In other words, when oil price increase, investors observe the fear that concern on economic growth makes the stock price

to fall

It is hypothesized that there is negative relationship between oil price and stock return

2.4.6 The impact of gold price on stock return

Twite (2002) studied a small sample of the gold mining company in Australia and found their values were affected by changes in the price of gold Hondroyiannis and Papapetrou (2001) found a relationship between gold prices and gold mining stocks In a recent study of John Leyers (2007), he discovered that gold had relationships with the circumstances of the country when he observed in 15 years, the relationship is negative, but in the short term the relationship is positive In most of the test equation, he found that most indicators had a positive correlation For investors, nowaday, gold may no longer be considered as a hedging tool anymore

Investors often invest gold to hedge in both directly and indirectly Gold prices had historically been considered "storm shelter" to help to avoid damages during inflation, social unrest, and war - the period that stock prices always decline In crises like today, gold prices rose sharply when the stock price falls Indirect gold investment, such as investment in the shares of gold mining is often better to invest directly in gold in this time when gold prices

have made many mining companies became beings “chicken laying golden eggs” The financial adviser is usually quick to advise investors to maintain a gold position in the challenging moments In contrast, in boom times, investors often reduce the value of gold when stock prices rise, as evidenced by the early 1990s when inflation is reduced or non-existent Investors do not invest in gold and consider that gold is not a hedging tool In that time, gold only is seen as a valuable commodity is determined by supply and demand

Investors have the habit if risk management in which they diversify their portfolio across assets including gold and oil because the two assets have the independent movement to stock market Technologies have changed the investment environment in which there are invisible barriers to investors buying or selling goods everywhere on Earth Several papers show that there is a negative relation between gold and stock market, and the relationship tends to change over time Some definite relationship implies that traditional diversification is not favored nowadays

It is hypothesized that there is negative relationship between gold price and stock return

2.4.7 The impact of different stock markets on each other

In the process of deeper and deeper integration, the region’s market in particular or the financial world one, in general, are affected by the increase or decrease fluctuations in the stock price index, and this is understandable The high or low level of impact depends on the degree of integration of that market with the world market

Forbes and Rigobon (1999) has found no impact on equity markets during the Asian crisis in

1997, the devaluation of Mexico in 1994, and the U.S recession in 1987, but had a strong linkage of stock markets in Southeast Asia, Latin America, and in OECD countries

Patricia Fraser and Oluwatobi Oyefeso (2005) consider the long- term correlation between the U.S, the UK, and the four European markets Boschi M (2005) analyzed the influence of the crisis infecting Argentina by estimating VAR models and the correlation coefficient for Brazil, Mexico, Russia, Turkey, Uruguay, Venezuela and there is no evidence for appeared that the infection Wang, Yang, and Bessler (2003) has analyzed African countries Hamori

and Imamura (2000) analysis of the G7 countries and Hirayama (2004) has analyzed Japan, the UK and the U.S, Tsusui and Hirayama (2003) had analyzed Japan, Britain, Germany and the U.S

Yang and Min (2003) focus on the relation between stock markets of different countries in Asia, including that, examine the long-term relationship between the US, Japan stock markets and five emerging markets in Asia The connection between equity markets tends to change over time, especially surrounding period having the economic recession Papers that study Asian stock market do not have much analysis on China market However, this market has grown rapidly recently Yan Shang examined the relation between Asian stock markets such as Japan, Singapore, Hongkong, China and US, a market having great impacts on Asian stock in periods surrounding financial crisis in 1997 He discovered that in the crisis period, the stock price of countries almost has a positive relationship with each others and that after the crisis, the correlation tends to increase US stock market has the greatest impact on Asian stock

It is hypothesized that there is a positive relationship between different equity markets on each other In my paper is S&P500 return and Viet Nam stock return

2.5 Conceptual framework

TABLE 2.1 CONCEPTUAL FRAMEWORK

To understand how macro variables impact the stock market, I study the relationship between the above variables on stock return My initial hypotheses are as below:

Higher industrial production will result in a higher stock return and vice versa because of industrial production index always follows economic cycles, example, it increased during the economic recovery, economic booms and declined during a recession It is often used as a measure of the level of economic activity An increase in industrial output is a signal for economic growth It is hypothesized that there is a positive relationship between growth of industrial production and stock return

The Higher inflation rate will result in a lower stock return and vice versa because of high inflation is an indication that the economy is hot, signal of unsustainable growth, while the stock market like a thermometer to measure economic health When high inflation, currency depreciated, people did not want to hold cash or deposits in the bank that switched to holding gold, real estate, stable currencies This caused to a considerable amount of idle capital of the society lies dormant as the dead asset Lack of investment capital, no accumulate to expand production, the growth of enterprises in particular and the economy in general will slow down Therefore, it is hypothesized that there is a negative relationship between inflation and stock return

The Higher interest rate will result in a lower stock return and vice versa When interest rates tend to fall, inflation will falls and it makes stock price higher Therefore, it is hypothesized that there is a negative relationship between interest rate and stock return

Higher exchange rate will result in a lower stock return and vice versa because of a depreciation of the currency will result in a portfolio of foreign assets transferred from the inland to the external assets due to the devaluation has reduced the income of foreign investors The withdrawal of foreign investors could cause a drop in stock prices Therefore,

it is hypothesized that there is a negative relationship between exchange rate and stock return

Higher oil price will result in a lower stock return and vice versa because of oil prices is a factor input in the production process An increase in oil prices will increase production costs put pressure on the entire value of securities In other words, when oil prices rise, investors observed that economic concerns will make stock prices fall Therefore, it is hypothesized that there is a negative relationship between oil price and stock return

Higher gold price will result in a lower stock return and vice versa because of investors have the habit of using risk management strategy to diversify their portfolio with different types of commodities including gold as an essential collection Therefore, it is hypothesized that there

is a negative relationship between gold price and stock return

Higher stock return in other markets will result in a higher stock return and vice versa Vietnam stock quite affected by the global stock For example, when the stock of the United States or China gained will help Vietnam stock prices in the short term Therefore, it is hypothesized that there is a positive relationship between stock return in other markets and stock return

CHAPTER 3: RESEARCH METHODOLOGY

This chapter includes four main parts The first part introduces date source of my paper The second part provides the impact of each independent variable and stock return The last part summarizes some of the results of testing the macroeconomic impacts on stock return The last part analyzing the stock return of VN index by multivariate model including correlation matrix, regression model and the findings from the empirical model

3.1 Data source

Data is collected in monthly observation

I conduct my research using time series from 01/2004 to 08/2013 I have 116 monthly observations to test the relationship between stock return and macroeconomics The macroeconomics variables are industrial production, inflation, interest rates, exchange rates, gold price, oil price and S&P 500

Source of data: Vietnam index (VN index) is the official published index of the weighted value of closing price for all share listed on Hochiminh city stock exchanged Industrial production, inflation rate (CPI), exchange rate, interest rate, gold price have been collected from General Statistic Office of Vietnam (GSO) Oil price is FOB average price trading volume of the whole world and it can be collect from US energy information Administration S&P 500 can be collected from American stock exchanged

market-TABLE 3.1: THE EXPECTED SIGN OF VARIABLE IN MODEL

Yt Yt = log (VNindext/ VNindext-1),

representing the return of

VNindex

IPt TPt= (industrial productiont /

INt INt= (CPTt / CPIt-1) – 1,

representing the % change in CPI

% Negative Paolo Giordani and Paul

Soderlind (2002), Fama and Schwert (1977), Geert Bekaert and Eric Engstrom (2008), A.Ang, G.Bekaert, and M.Wei (2006), Wandi B Bruin, Charles F Manski, Giorgio Topa, Wilbert van der Klaauw (2009) and Jaffe – Mandelker (1976), Geert Bekaert and Eric Engstrom (2008)

IRt IRt= (interest ratet / interest ratet-1)

– 1, representing the % change in

interest rate

% Negative Graham and Harvey

(2001), Bartram (2002),

P Moya-Martineza, R

Ferrer-Lapenab, and F Escribano-Sotos (2007), Fama & Schwert (1997), Reily & Brown (2000)

EXt EXt= (Exchange ratet / exchange

ratet-1) – 1, representing the %

change in VND/USD

% Negative Phan Thi Bich Nguyet

and Pham Duong Phuong Thao (2013), Desislava Dimitrova (2005), A Hatemi-J and M Irandoust, (2002), Y Hsing (2004)

Oilt Oilt= (Oilt / Oilt-1) – 1,

representing the % change in Oil

price

% Negative Phan Thi Bich Nguyet

and Pham Duong Phuong Thao (2013), Hamiltion (2008)

Goldt Goldt= (Goldt / Goldt-1) – 1,

representing the % change in Gold

price

Hondroyiannis và Papapetrou (2001), John Leyers (2007)

and Min (2003)

3.2 Methodology

In this study, seven macroeconomic variables are examined The model below is designed

to test the effect of those macroeconomic variables on the stock return The factors tested are the term structure of industry production, inflation, interest rate, exchange rate, oil price, gold price, different stock markets The variables formulated into a linear model as suggested by Chen, Roll and A.Ross (1986) as follow:

Yt = β0 + β1IPt+ β2INt+ β3IRt+ β4EXt + β5Oilt + β6Goldt + β7Pt + εt

where, Yt actual return on the portfolio; β is the reaction coefficient measuring the change in portfolio return for change in risk factors, IP, IN, IR, EX, Oilis, Gold, P are the macroeconomic factor In this study, the factors tested are: IPt, representing the % change industrial production; INt representing the % change in CPI; IRt representing the % change in interest rate; EXt representing the % change in VND/USD; Oilt representing the % change in Oil price; Goldt representing the % change in Gold price; Pt representing the return on S&P500 index; εt is a residual error for portfolio The simplest of theories of pricing a financial asset is through discounting futur cash flow The variables that affect future cash flows or risk adjusted discount rate of a company must be considered The aim of explaining the variables is to measure the macroeconomic forces that influence the stock returns

CHAPTER 4: RESEARCH RESULTS

4.1 Bivariable analysis:

4.1.1 The impacts of Industry production and stock return

Figure 3.1 The proportion of the value of good in Viet Nam from 2009 to 2013

(Source: General Statistic Office of Vietnam)

Growth in industrial production value is often considered as an important factor affecting the rate of return on the stock market, as evidenced by the appearance of variables in the macro model of Chen, Roll, Ross (1986) Industrial production value is offen used as a replacement for GDP growth variable, simple, when GDP go up , the stock market will go up

The relationship between variables and the stock market in Vietnam is examined by the figure below: