Examine the causal relationships between finance and macro variables.
For a country of your choice, download enough data (get the maximum number of observations) on the following variables: stock market index, inflation rate, output (Industrial Production), and interest rate. Use this data to study the relationships between stock market index, inflation rate, output (Industrial Production), and interest rate. To do so, you need to answer the following questions:
[10 marks] Compute and discuss the descriptive statistics of your time series (in levels and logs). Plot the series and describe patterns.
[10 marks] Report and comment on the ACF/PACF functions of stock market index, inflation rate, output, and interest rate and their first-differences in log.
[20 marks] Use appropriate Dickey–Fuller tests to test if the variables stock market index, inflation rate, output, and interest rate and their first-differences in log are non-stationary (have a unit root) or not. Explain the test procedure, report the test statistics and the appropriate critical values (at 5% significance level) and discuss the results.
[20 marks] Test for cointegration among the four variables using Johansen’s tests. Explain the test procedures, report the test statistics and the appropriate critical values (at 5% significance level). How many macro variables are cointegrated with stock market price? Discuss the results.
[30 marks] If you have found one or more cointegrating relations, estimate the long-run causal relationships (i.e., the cointegrating relations) and the Vector Error Correction Model. Otherwise, use the Box-Jenkins procedure to estimate a VAR model for the appropriately transformed (de-trended or differenced) variables. Report the results of Granger causality and the impulse response functions. What are the macro variables that affect stock market price? Discuss the results.
[10 marks] Find three published papers on the relationship between stock market index and the above macro variables and discuss/compare your results to those obtained in these papers.
