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International Journal of Applied Econometrics and Quantitative Studies Vol.1 -1(2004)






Previous research has hypothesized the existence of a long-term

equilibrium relationship between stock prices and certain macroeconomic variables. The vector error correction model (VECM) (Johansen (1991)) is utilized to determine the impact of selected macroeconomic variables on Amman Stock Exchange (ASE). The variables are the real economic activity, money supply, inflation, and interest rate. The empirical results show that the stock prices and macroeconomics variables have a long-term equilibrium relationship.

JEL classification: G15 Keywords: Jordan; Amman Stock Exchange; Johansen method

1. Introduction Despite the unfavorable political and economic conditions in the region, the Amman Stock Exchange (ASE) managed, for the second consecutive year, to sustain an outstanding performance. This was evident in the encouraging financial results of most indices, excluding the general share p rice index, which dropped by a small percentage compared to the decline of most international financial markets. The bourse's better performance in 2002 was partly due to the government policies aimed at enhancing the investment climate in the Kingdom and spurring economic growth. The increase in the profitability of public shareholding companies, the bourse's qualitative technological advancements, and the boost in investors' * Adel A. Al-Sharkas, Ph.D. Assistant Professor of Finance, College of

Business, Alfred University, Saxon Dr. Alfred, NY 14802. Email:

alsharkasa@alfred.edu 97 Al Sharkas, A.A. Dynamic Relations Between Macroeconomic Factors and Jordanian..

confidence in the Jordanian capital market, also contributed to a better performance.

The trading volume in 2002 increased by 42.9 percent, to JD 946.7 million, a record level since 1993. The boom was triggered by a 37.1 percent increase in the number of traded shares, due to the listing of Jordan Telecom shares on the bourse. At the sector level, the industrial sector witnessed the highest increase in the trading volume, reaching JD 208.3 million. Thus, the relative importance of the trading volume of this sector vis-a-vis total trading rose by 10 percentage points, to reach 49.8 percent. In contrast, the relative importance of trading volume for "banks and financial companies", and services sectors decreased by 8.9 and 1.9 percentage points to reach 36.9 and 12.1 percent, respectively. As for the insurance sector, the relative importance of trading volume registered a minimal increase (0.2 percentage points) to reach 1.2 percent.

The general share price index, in light of the unfavorable regional circumstances, dropped by 1.6 percent, to 170 points, compared to a

29.8 percent increase during 2001. The drop was the outcome of a decline of 19.5 points (7.1 percent) in the "banks and financial companies" sector index, and a decline of 3.4 points (3.1 percent) in the services sector index. On the other hand, the indices of the insurance and industry sectors rose by 16.7 points (12.5 percent) and

9.9 points (10.8 percent) respectively. Worth mentioning here is that the market capitalization of listed stocks in the bourse also increased by 12.3 percent, to JD 5,029 million, in 2002 (around 76.4 percent of GDP). This rise is attributed to the listing of the Jordan Telecom shares in the bourse. Activity in the market for fixed income securities (bonds) remained relatively marginal; total value of bonds traded on the bourse during 2002 did not exceed JD 9.7 million.

As for non-Jordanian investments in the bourse, data revealed that non-Jordanian investors purchased JD 233.4 million worth of shares, double the amount bought in 2001. Meanwhile, they sold stocks worth JD 232.5 million. Consequently, net non-Jordanian investments in the ASE showed a positive balance of JD 0.9 million

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last year, compared to a negative balance of JD 107.5 million in 2001.

A number of technical developments that took place at the bourse also allowed for increased transparency and efficiency, and for better services. These included refurbishing the manual trading hall and turning it into an investors' hall, where investors can monitor trading activity and prices. The bourse also completed the first and second stages of the management information system, set to streamline procedures at all ASE departments. Within the legislative context, the new temporary Securities Law No. 76 for the year 2002 entered into force. The Law includes key amendments that seek to boost the efficiency of the stock market and allow for the establishment of other bourses besides the ASE. It also allows for the creation of an independent fund to protect investors.

Despite the importance of previous studies, until now the majority of research considers developed countries financial markets, which are efficient enough and do not suffer from the inefficiency problems in less developed countries. Considering this matter, the subject of financial markets in developing countries still needs lengthy analysis and more research attention. Therefore, the importance of this study stems from it being an empirical attempt in this direction. I select five macroeconomic variables based on their hypothesized effect on either stock pricing or return. The ASE is also a well-established, small, emerging open equity market, thus, providing a showcase for other emerging markets in the world.

The principal objective of this paper is to use the cointegration method of Johansen (1991) to analyze the long-term equilibrium relationship between stock returns and relevant macroeconomic variables for the Jordanian (Amman) stock market. Series of studies have been done to find the long-term equilibrium relationship between stock returns and macroeconomic variables for the USA, Japan, and other industrially developed countries. Furthermore, the paper addresses this question for the first time in the Jordanian stock market. In particular, it attempts to find whether there exists longterm equilibrium relationship between the Jordanian stock market 99 Al Sharkas, A.A. Dynamic Relations Between Macroeconomic Factors and Jordanian..

return and the level of real economic activity, money supply, inflation, and interest rates. The results indicate that a cointegration relationship indeed exists and that stock prices contribute to this relationship.

This paper’s contributions are as follows. First, by employing Johansen’s VECM, which has become a standard technique for examining cointegration among financial variables, the current paper provides a more appropriate framework than the standard vector autoregressive (VAR) technique.1 The advantage of the cointegration technique stems from its ability to explore dynamic co-movements among variables examined. On the other hand, the VAR approach is deficient in its failure to incorporate potential long-term relations and, therefore, may suffer from a misspecification bias.

Second, studying the relationship between the macroeconomic indicators and the Jordanian stock market can shed some light on the stock market’s response to macroeconomic factors for similar emerging and industrial markets as well. In Table 1, I report the market capitalization of the whole market, the size of new equity issues, and their respective proportions to GDP. When judged by the ratio of market capitalization to GDP, the mean proportion of 55% indicates the importance of the market in the Jordanian economy.

Moreover, during the time period 1978-1999, the mean annual equity issues as a proportion of GDP was equal to 1.13%. During the time period 1991-1995, “this proportion was equal to 0.6% in Germany, 1.0% in Japan, 0.5% in Turkey, 0.4% in Greece and 0.5% in Portugal” (Aylward and Glen, 1999, p.35).

The paper proceeds along the following lines. Section 2 describes the recent macro variable trend in Jordan. Section 3 presents the literature review. Section 4 discusses the data and the methodology.

Section 5 reports the empirical results, and Section 6 provides conclusions.

1 Darrat (1990) applies a VAR model to examine the relation between stock returns and macroeconomic variables.

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2. Recent Macro Variable Trends in Jordan Macroeconomic indicators in the year 2002 have shown an improvement in the performance of the economic activity. Primary figures presented in the "Budget Address for the year 2003" expect that the GDP growth in fixed prices will be 5.0% for 2002, compared to 4.2% for the year 2001, whereby the GDP would reach JD 6,780 million in current prices.

As for the monetary policy, the Central Bank of Jordan (CBJ) pursued its policy which aims at maintaining monetary stability, a strong and stable Jordanian Dinar exchange rate, a low inflation rate, and low interest rates. This policy has helped to keep a comfortable level of foreign currency reserves at the CBJ, equaling JD 2,477.7 million by the end of 2002, which is the highest level since the Kingdom was established. As for interest rates, the discount rate dropped from 5.0% by the end of 2001 to 4.5% by the end of 2002, the weighted average of interest rates on loans and advances went down from 10.45% to 9.85%, interest rates on three months certificate of deposits (CDs) decreased from 3.9% to 3.0%, and the consumer price index went up by 1.8% during 2002.

On the public finance performance, re-estimated figures indicate a drop of 8.5% on the expected level of domestic revenues for the year 2002 and a decrease in general expenditures of 5.2%, thus the fiscal deficit would amount to JD 260 million, i.e. 3.8% of the GDP.

Domestic debt figures indicate a rise in its outstanding balance by the end of 2002 to JD 1335 million, 19.7% of the GDP, against JD 1,124 million, or 18% of the GDP, by the end of 2001, namely an increase of 18.8%. This increase in the outstanding balance of public domestic debt is due mainly to treasury bonds and bills issued to finance part of the budget deficit. On another vein, the external debt outstanding increased to JD 5,123 million by the end of 2002, 75.6% of the estimated GDP for 2002, against JD 4,743 million or 75.8% of the GDP as of end the of 2001. Thus, registering an increase of 8%, as a result of the increase in the exchange rate of the Yen and the European currencies against the Jordanian Dinar.

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3. Literature Review Chen, Roll and Ross (1986) contribute to the fact that a long-term equilibrium relationship exists between stock prices and relevant macroeconomic variables.2 They find that asset prices react sensitively to economic news, especially to unanticipated news.

Hamao (1988) replicated the Chen, Roll and Ross (1986) study in the multi-factor APT framework. He shows that the Japanese stock returns are significantly influenced by the changes in expected inflation, and the unexpected changes in both the risk premium and the slope of the term structure of interest rates. The volatilities in real economic activity in Japan are weakly priced compared to the U.S.A.

Lee (1992) investigates the causal relationship and dynamic interaction among asset return, interest rates, real activity and inflation, using a multivariate VAR model with postwar U.S. data.

He shows that prior stock returns Granger-causes real stock returns.

Darrat (1990) tests the joint hypothesis that the stock market of Canada is efficient and the expected returns are constant over time using the multivariate Granger-causality technique. He finds that the Canadian stock prices fully reflect all available information on monetary policy moves.

Darrat and Mukherjee (1987) use a Vector Autoregression (VAR) model along with Akaike’s final prediction-error on the Indian data over 1948-84, and show that a significant causal relationship exists between stock returns and certain macroeconomic variables. Brown and Otsuki (1990) find that money supply, production index, crude oil price, exchange rate, call money rate and a residual market error are associated with risk premia and affect the Japanese stock market.

Mukherjee and Naka (1995) test the dynamic relationship between six macroeconomic variables and the Japanese stock market, by employing a vector error correction to a model of seven equations.

They find that a long-term equilibrium relationship exists between the Japanese stock market and the six macroeconomic variables such 2 Granger (1986) provides the foundation of the validity of this fact by using a cointegration analysis.

–  –  –

as exchange rate, money supply, inflation, industrial production, long-term government bond rate and call money rate. More recently, Sadorsky (1999) finds that industrial production responds positively to the shocks in stock return and that oil prices play in affecting real stock return. On the other hand, other studies left this matter as an open question as to whether there exists a significant reliable statistical relationship (Homa and Jaffee, 1971;Fama, 1981;and Gultekin, 1983).

4. Data and Methodology

4. a Summary Statistics The data used in this study were obtained from various issues of the monthly statistical bulletins from the Central Bank of Jordan. The stock data were collected from the Amman Security Market statistical data. The sample period consists of 92 quarterly observations for each variable, from March 1980 to December 2003.

The variables used to represent Jordanian stock market, inflation, money stock, output (real activity), and interest rate are respectively the Amman Stock Exchange Index (ASE), Consumer Price Index (CPI), Money supply (M2), Industrial Production Index (IP), and Treasury bill (TB) rates. The choice of variables is almost similar to Chen, Roll and Ross (1986), Darrat and Mukherjee (1987), Hamao (1988), Brown and Otsuki (1988), Darrat (1990), Lee (1992) and Mukherjee and Naka (1995). The definition of the variables is provided in Table 2.

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