Abstract:
Investigations of relationship between macro-economic factors and performance of stock markets at many
emerging economies including that of Sri Lanka are relatively limited on one hand and required to be repeated
as the underlying economic settings of such economies have rapidly changed over the years. Post war economic
context and subsequent macro-economic revitalizations in Sri Lanka influenced the performance of capital
market of Sri Lanka and hence the investigations on ‘how does and at what extent the Sri Lankan stock market
responds to such macroeconomic developments?’ is an important empirical question. This study thus
investigates the relationships between the All share price index of Colombo stock exchange and five
macroeconomic variables, namely, Gross domestic product (GDP), Inflation proxied by wholesale price
index(WPI) , Interest rate (IR), Balance of payment (BP) and Exchange rate (ER) over the period from 1980 to
2012. Ordinary Least Square (OLS) is used to estimate the parameters of the regression model, with the
application of linear, linear- log, log- log and log- linear data transformation for choosing the appropriate model
fitting the data. The serial correlation problem was tested using Durbin-Watson statistics. In this study, DurbinWatson statistics of the log-log model, which had the highest R2 of 82%, was 1.88 confirming that there was no
serial correlation issue. The analysis reveals that macroeconomic variables and the stock market index (All share
price index) in Sri Lanka are significantly related. It is observed that the stock market index significantly
positively relates to GDP, ER and IR while it negatively relates to inflation proxied by wholesale price index of
Sri Lanka. The Balance of payment is found to be insignificant in determining the stock market performance in
Sri Lanka
