Error Correction Model

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Over the last several decades, the relationship between the stock markets and macroeconomic variables has become the subject of interest for the researchers. By applying different econometric techniques, researches proved that in some countries the interdependence between the macro variables and stock market is present indeed. For example, Islam (2003) applied the Error Correction Model to analyze both the short- and the long-run dynamics between Indonesia’s stock market (the Kuala Lumpur Stock Exchange Composite Index) and several key macroeconomic variables, such as the short-term interest rate, inflation, exchange rate and industrial productivity. For the purpose of the research, the data was collected for the period from January 1990 to …show more content…
The author employed the Distributed Lag Model in conjunction with VAR approach to examine the effect of the crisis on Singapore’s stock market. The effect of the financial crisis was determined by analyzing the pre- and during-the-crisis dynamics of several key macroeconomic variables and Straits Times Industrial Index prices. As a result, the paper found empirical evidence of the monetary policy irrelevance in Singapore but positive influence of the fiscal expenditures on the STII index price. Furthermore, the negative relationship between the exchange rate and STII was discovered in both pre- and during-the-crisis periods. Regarding the interest rate influence on the stock index price, the evidence of the positive relationship was found for the during-the-crisis …show more content…
They used several co-integration analysis techniques as well as Granger causality test to investigate both short- and long-term dynamics between the US and Singapore stock market indices prices and several macroeconomic variables during the period from January 1982 to December 2002. The empirical evidence suggests that there was co-integration relationship between the Singapore’s stock market and both interest rate and money supply (M1) but no equivalent long-term equilibrium relationship present in the US. With regard to the short-run relationship between the variables, it was analyzed using the same method but for the shorter time period data samples. As a result, the evidence suggests that there was a short-run relationship between the Singapore’s and US’s stock market prices and both interest rate and money supply in the pre-crisis but not in the after-crisis period. The same results were also achieved by applying the fractional co-integration analysis and Johansen’s multivariate
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