DYNAMIC REACTION OF SECTOR-SPECIFIC INDICES AND MACROECONOMIC FUNDAMENTALS

Abstract

This study focuses on the issue of dynamic reactions between sector-specific indices of Bursa Malaysia and macroeconomic variables. The traditional variable under observation in analyzing stock market performance has been an aggregate stock market index. However, the application of an aggregate index could lead to misleading interpretation on the actual performance of each sector in Bursa Malaysia. It is believed that variations in macroeconomic variables could have different effects on sector-specific indices in terms of magnitude and persistence. Therefore, the main objective of this study is to analyze the long-run dynamic interaction between sector-specific indices of Bursa Malaysia and macroeconomic variation by proposing certain model for each sectoral index. Specifically, the proposed models refer to the periods of before and after the 1997 financial crisis as well as a full period model with a dummy variable. All of the models emphasize on the aspects of magnitude, persistence and direction of the responses by sectoral indices due to shocks in macroeconomic variables. The sectoral indices of Bursa Malaysia selected for this study are namely, Construction, Plantation, Consumer Product, Finance, Industrial Product, Mining, Hotel, Property and Trading and Services. The macroeconomic variables are represented by real economic activity, interest rate, inflation rate, money supply and exchange rate. The monthly data series of the macroeconomic variables and stock market indices are obtained for the period from 1993 to 2006. In the analysis, the aspects of structural stability and application of a dummy variable have been taken into consideration so as to develop accurate and stable models. The application of a lag operator in analyzing the relationship between the variables has also been considered. This study shows that most of the movements of the sectoral indices of Bursa Malaysia have been explained by variations in macroeconomic variables in the long-run. This study has also identified various trends of responses among the sector-specific indices towards the innovation in macroeconomic variables. The results suggest that unanticipated changes in macroeconomic variables could lead to similar patterns in some of the sector-specific indices with the effects differing mainly in terms of magnitude as well as persistence of the responses that occur following the shocks.

Keywords: Dynamic reactions, sector-specific indices, cointegration, vector error correction model, impulse response functions and variance decompositions