Is Indian Stock Market Related with Exchange Rate and Inflation? An Empirical Test Using Time Series

The purpose of the paper is to establish and validate the long term relationship of stock prices with Exchange rate and Inflation in Indian context. There are numerous studies on the relationship of stock indices with macro economic variables. This gives a strong subjective background to test the existence of any such relationship in India. The paper primarily deals with an empirical method by combining different statistical techniques to check the presence of cointegration between the stock index (Sensex) and other variables. Cointegration is a well accepted indicator of a long term relationship between more than one time series variables. Concepts of ARIMA time series modeling (up to identification stage) and regression are also visited to the extent required for the study. A step by step process was followed, though a basic one, to bring out the conclusion regarding the existence of cointegration between the given time series variables. The study takes into consideration past ten years experience of Indian economy reflected into the stock index, wholesale price index and exchange rates. A causal relationship could not be established without the existence of cointegration between the selected macro-economic variables. The paper also tries to combine the techniques with sophisticated statistical software by using SAS for all the statistical processes used. At the end, the paper also explains various other factors which may affect the outcome of the quantitative techniques used. It also puts emphasis on the strong subjectivity of the inferences drawn from the results