Co-Integration Analysis of Macroeconomic Variables as Determinants of Equity Market Premium

Wu Mengyun, Muhammad Imran, Muhammad O. Farooq, Muhammad Abbas, Allah Yar, Muhammad Ilyas and Rabnawaz Khan

Stock market of any country plays a vital rule in discovering the economic development and growth progress. The industrial growth and its importance cannot be overlooked in economic growth. Companies issue share to generate capital for their expansion and new opportunities. Investment in stock market not free of risk and investor always demand for high return due to the risk they are taking. In this research the equity premiumand its determinants are highlighted. The equity premium has been calculated by taking the difference of market return and interest free returns. Monthly data has been used in this study ranging from July 2001 to Dec 2014. Co-Integration test has confirmed that there is long term relationship between endogenous and exogenous variable. The Granger Causality test were also applied and found that interest rate does granger cause to equity risk premium followed by exchange rate that causes equity risk premium at 10% significance level. Also exchange rate does granger causes to interest rate. Variance decomposition and impulse response showed that interest rate has significant effect followed by exchange rate and Inflation over equity premium. Foreign private investment has no or very little effect on equity premium