The impact of macroeconomic indicators on stock prices in vietnam , luận văn thạc sĩ

Beyondthe basic microeconomic factors such as supply and demand, the relationshipbetween stock prices and macroeconomic variables such as industrial production,interest rates, inflation

International School of Business

-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

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 ofBusiness (ISB) – University of Economics Ho Chi Minh City (UEH) – forsharing their knowledge and experience during my master course Enthusiasticassistance provided by the ISB’s executive board and staffs was also greatlyappreciated

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

Finally, I would like to express my special thanks to my wife for hersupport 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

Ho Chi Minh Stock ExchangeInternational Financial Statistics

Industrial Production IndexInitial Public OfferingInterest Rate

Ordinary Least Squared

Statistical Package for the Social Sciences

VAR Vector Autoregressive

CHAPTER 1: INTRODUCTION

This chapter introduces the background of the stock market including theVietnamese stock market Next, the research problems and research objectives areidentified Furthermore, the significance and scope of the research are alsopresented Finally, the research structure gives an overview of the structureorganized 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 asignificant component of a country’s financial system and plays very importantroles in the economy One of the major roles that the stock market plays is tomobilize the savings By mobilizing of savings, stock markets help to bridge thegap between savers and investors in an economy Stock markets provide servicesand benefits to governments, enterprises, and investors In fact, governmentsthemselves 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 aninitial public offering (IPO) on the stock exchange to mobilize new capital for theirbusiness Moreover, the stock market is also a place where investors can diversifytheir portfolio in order to reduce the risks by investing in different stocks Stockprice, therefore, becomes a matter of general concern of people including

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

In economic theory, the price is mostly affected by supply and demandrelationship This principle is also true for the stock price If the demand for ashare 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 Beyondthe basic microeconomic factors such as supply and demand, the relationshipbetween 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 studiescarried 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 ofsimilar 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 StockExchange (HOSE) and Hanoi Stock Exchange (HNX), is one of the emergingmarkets 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 attractingattention 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 fromthe end of 2007 onwards The year of 2007 is the year that the Vietnamese stockmarket was in a stock market bubble The stock price index reached a peak at1170.7 points in March 2007 There are many factors leading to the fluctuations inVietnamese stock price, such as international and domestic economic uncertainty,psychology of investors Despite the fact that the Vietnamese stock market ispotential for investors, there is limited empirical study investigating therelationship between stock prices and economic indicators, especiallymacroeconomic indicators (Hussainey & Ngoc, 2009) Therefore, the question ofwhether or not the macroeconomic indicators affect Vietnamese stock prices isalso concerned

2013 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 onstock prices and offer evidence that macroeconomic variables affect stock pricessuch 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 researchesare quite different or even opposite in different countries For instance,Wongbangpo and Sharma (2002) determine a negative relation between interestrate 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 howmacroeconomic indicators influence stock prices in emerging markets, especially

in Vietnam (Hussainey & Ngoc, 2009) Hussainey and Ngoc also state that theirstudy is the first study that investigates the effects of macroeconomic indicators onVietnamese stock prices They believe that their paper provides a significantcontribution to the existing literature, as the authors are the first to examine thisissue in Vietnam Nevertheless, the limitation of their study is that this study onlyexamines the impact of two domestic macroeconomic indicators (namely interestrate and industrial production), and international factors (US macroeconomicindicators) on stock prices Their recommendation is that other macroeconomicvariables should be included in the model in order to make the results becomemore valid

1.3 Research objectives

The main aim of this study is to examine the impact of four keymacroeconomic 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:

macroeconomic indicators and Vietnamese stock prices exist?

short run?

1.4 Significance of the research

Since the Vietnamese stock market is still immature, it is necessary to havemore and more researches into the Vietnamese stock market so that people canunderstand more about the stock market and help develop the stock market in asustainable way By examining the relationship between macroeconomicindicators and stock price, the findings of this paper are expected to offerimplications that can help the policy makers, managers of listed companies andinvestors to predict how the stock price changes if macroeconomic indicatorsfluctuate

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

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

Moreover, the findings drawn from this study can help the investorsunderstand 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 moreprofits based on their understanding of macroeconomic information For instance,

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

1.6 Research methodology and scope

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

relationship among variables or not

● Applying Vector Error Correction Model to investigate the long run aswell as the short run relationship if there is a cointegration relationship amongvariables

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

1.7 Research structure

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

research including research background, research problems, researchobjectives, 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 studiesregarding the relationship between macroeconomic factors and stockprices In addition, the hypotheses, which are tested in this research, arealso set

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

process, measurement of variables, data collection and methods of dataanalysis 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 empiricalresearch are also analyzed.

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

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

CHAPTER 2: LITERATURE REVIEW

This chapter reviews relevant theories as well as the findings of previousempirical studies regarding the relationship between selected fourmacroeconomics and stock prices Based upon these studies, hypotheses andconceptual model are proposed

2.1 Theoretical framework

There are many theories that mention the relationship betweenmacroeconomic variables and stock prices This study bases on two of them,namely the top-down approach and dividend valuation model or present valuemodel in order to explain that relationship

2.1.1 The top-down approach

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

2.1.2 The dividend valuation model

According to Gitman, et al (2004), the intrinsic value of any investmentequals 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 thedividends will be received over an infinite time From this perspective, the value ofshare is equal to the present value of all the future dividends expected to provideover an infinite time This approach, which believes that the value of a share is afunction of its future dividends, is known as the dividend valuation model (DVM).The DVM can be expressed as the following equation:

Where:

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 allfuture dividends or the expected cash benefits Therefore, any economic factor that

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 economicactivity When compared to previous year’s figure, it depicts how fast the economy

is growing or contracting In theory, industrial production increases duringeconomic expansion and decreases during a recession A change in industrialproduction, therefore, would signal a change in the economy The productivecapacity of an economy rises during economic growth, which contributes to theability of corporations to generate more cash flows As mentioned above, sincestock 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 economicgrowth, even up or down, can affect the stock price through investor’s investmentdecision making For instance, if investors believe that the economy is growingand companies are making more profits along with economic growth, they will bewilling 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 thestocks or pay less for buying them, resulting in a fall in stock prices

Moreover, Wongbangpo and Sharma (2002) claim that a growth in outputincreases expected future cash inflows and profitability of enterprises that create ahigher future dividend With the expectation of higher dividend, investors arealways willing to buy shares at a higher price As a consequence, the share pricewill go up In contrast, the opposite outcome is likely to occur in a recession Itmeans 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 thereexists a positive association between stock price and industrial production.

Many empirical studies use the industrial production index as a proxy foreconomic activity The growth of production may be consistent with the averagegrowth of the company’s sales and its cash flows Therefore, industrial productionindex should be useful in the asset pricing model (Chen, et al., 1986) Furthermore,several empirical studies in emerging markets show the positive relationshipbetween real economic activity and stock price In the most recently publishedresearch, El-Nader and Alraimony (2012) examine the relationship betweenAmman stock market return and Jordanian macroeconomic factors They use realgross domestic product (GDP) as a representative for real economic activity andpoint 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 byWongbangpo and Sharma (2002) shows the similar result They point out thatstock prices in all five Asian countries, namely Indonesia, Malaysia, Philippines,Singapore, and Thailand are positively related to growth in output, which isrepresented by gross national product (GNP)

between industrial production and stock prices in Istanbul stock exchange inTurkey between 1991 and 2000 They explore that industrial production has apositive impact on stock return, excluding the period which begins the 1994financial 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.

Figure 2.1 VN-Index and Industrial Production Index

Source: HOSE and GSO

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,

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 thecapital asset pricing model (CAPM)

Where:

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

investment

Since interest rate is often used as a proxy for the risk free rate, if interestrate changes, the risk free rate will change as well In fact, changes in interest ratesare expected to affect the discount rate in the same direction through their effect onthe risk free rates (Mukherjee & Naka, 1995) As the equation 2.2 shows, anincrease in risk free rate will lead the required rate of return to go up Based on thedividend valuation model (DVM) mentioned in the beginning of this chapter, ifnothing else changes, there will be a decline in share prices due to the higherrequired rate of return Conversely, if interest rates fall and everything else remainsconstant, 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 thebehavior of investors on the stock market From the perspective of asset portfolioallocation, the increase in interest rate will lead to the rise in opportunity cost Arise in this opportunity cost will motivate investors to substitute equity share forother asset in their portfolios (Apergis & Eleftheriou, 2002) More specifically,Apergis and Eleftheriou assume that there are bonds and stocks in an investor’sportfolio They claim that the relationship between stock prices and interest rateaffects investor’s portfolio With higher interest rates, investors would prefer bondsrather than stocks In that case, they are willing to buy bonds and sell stocks As aresult, 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 thecompany uses lending money for their operations Any rise in interest rate maycause a decline in future corporate profitability because of the rise in interestexpense The lower profits, the lower future cash inflows that will lead thecompany’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 gobankrupt In that case, investors will require higher risk premium Consequently,the share price will decline further Furthermore, a rise in cost of capital has animpact 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 stockprices and interest rates.

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

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

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

In the case of Vietnam, Hussianey and Ngoc (2009) utilize monthly dataduring a 9-year period from 2001 to 2008 to study this relationship They employbasic interest rates and government bond rates (ten years) as proxies for short termand 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 interestrates and stock prices, while long term interest rates have a negative impact onstock prices

In summary, the theories suggest a negative relation between stock pricesand interest rates However, empirical findings are mixed As mentioned above,Hussianey & Ngoc (2009) find out that the short term interest rate has a positiveimpact on stock price in Vietnam from 2001 to 2008 Based on this finding, thisstudy 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 tomove in the same direction from 2008 to 2013 Therefore, this study proposes thethe following hypothesis:

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

900

750

600

15450

Figure 2.2 VN-Index and Interest Rate

Source: HOSE and IFS

2.4 Relationship between inflation and stock price

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

2520

rate minus the expected inflation rate Therefore, inflation rate determines howmuch of real return of an investment will be lost when there is an increase in theinflation rate Moreover, inflation also affects the required rate of return, whichinvestors need to compensate for an investment, by influencing the nominalinterest rate Generally speaking, the inflation will affect the stock price in twoways The first way is through its impact on future real earnings and the secondway is through the way that investors discount future earnings.

By the first way, inflation reduces investments and therefore, economicgrowth and future earnings In fact, the inflation rate in an economy has a greatimpact on investor’s decision-making The investors are always faced with thedecision of whether to make investments or not An increase in inflation rate cancause the real income to decline If this case happens, the investors will end upselling their financial assets, including stocks As a result, stock prices will fall Incontrast, when the inflation rate is low, the investors would like to purchase morefinancial assets and stocks are not exclusive Regarding company, the impact ofinflation on stock prices actually comes from its effect on a company’s earnings Inthe case of low inflation, the company can keep the cost down and increases theprofits 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 discountfactor 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 iscommonly represented by interest rate, will increase as well In the case ofinflation 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 inApergis & Eleftheriou, 2002) In summary, theory suggests a negative relationshipbetween inflation rates and stock prices

With respect to previous studies, Udegbunam and Eriki (2001) examine theeffect 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 isspecified and estimated by Ordinary Least Square method Their finding indicatesthat 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 andinflation This finding is consistent with the results drawn from all five Asiancountries, 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 toinvestigate the relation between macroeconomic indicators including inflation andstock prices The finding of this study indicates the insignificant negative impact ofinflation on stock market performance of these countries In conclusion, all

empirical findings and theories state that there is a negative relationship betweeninflation 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.

Figure 2.3 VN-Index and CPI

Source: HOSE and IFS

2.5 Relationship between exchange rate and stock price

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

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

In addition, since there has been a considerable increase in economicglobalization, all businesses are affected directly or indirectly from internationalactivities 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 ofthe firm resulting in changes in the price of its stock

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

El-Nader and Alraimony (2012) also investigate the relationship betweenexchange 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 Lankaindicates 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 Theyfind out that the effect of exchange rates on stock prices in Indonesia, Malaysia,and the Philippines is positive Conversely, a negative relation between exchangerates and stock prices is found in Singapore and Thailand

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

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

900 25,000750

20,000600

15,000450

Figure 2.4 VN-Index and Exchange Rate

Source: HOSE and IFS

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.

2.7 Research model

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

STOCK PRICES

H3 (-) Inflation

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 themeasurement of variables; the third part is data collection; the fourth part is modelspecification; 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:

Research problem definition

Literature review

Hypotheses formulation

Research design

Data analysis and Interpretation

Conclusions & Implications

Figure 3.1 Research process

3.2 Measurement of variables

3.2.1 Dependent variable

Vietnamese stock prices are commonly represented by VN-Index (for HoChi Minh Stock Exchange HOSE) and HNX-Index (for Hanoi stock exchangeHNX) Based on the capitalization scale, operating time and the number of listedcompanies 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 forempirical work The monthly VN - Index was calculated by taking naturallogarithm 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 wereused 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 inflationrate, it is measured by the month-end consumer price index compared to thecorresponding period of previous year (El-Nader & Alraimony, 2012) As regardsexchange 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

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 collectionand 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 morereliable 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 ofsecondary data Moreover, journals, articles, and internet or public informationsources are also secondary data

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

Table 3.1 Description of variables

rate

index

3.4 Model specification

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

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 theequation 3.1 in order to be able to conduct a partial elasticity analysis (Colemanand Tettey, 2008), thus the impact of change in macroeconomic variables on thestock price index can be assessed, holding all other factors constant Therefore, theestimated equation was as follows:

3.5 Method of data analysis

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

was applied to find out if the variables are stationary or non-stationary The reason forconducting the unit root test was due to the use of time series data The time