Linkages Between stock indices, industrial production, and inflation of South Asian and So

A number of studies have examined the relationship between financial markets and  macroeconomic variables. For instance, Chen, Roll, and Ross (1989) suggest that equity returns are endogenous to economic variables as these economic factors affect the pricing of goods and services which in turn influence dividends either positively or negatively. Since stock prices are the present value of expected future dividends discounted at an appropriate interest rate, the economic factors are indirectly incorporated in these prices. The discount rate on the other hand, can change due to the level of unanticipated changes in interest rates and the risk premium.  The level of real changes in consumption or spending will influence the production of goods and services, its pricing in turn can affect the unanticipated changes in risk premium.  Cash flows of companies, in nominal terms and interest rates change with the levels of anticipated and unanticipated inflation. Therefore these changes should affect stock prices indirectly. Developing economies of countries that are in close proximity of each other tend to have closer linkages as there are less barriers to Foreign Direct Investments (FDI) for these economies due to regional cooperation and bilateral trade agreements.  Hence, it is expected that these economies will be closely bound together in the long-run. The results clearly support this as both inflation and stock indices are strongly integrated across South Asian and South East Asian Countries. It is also evident that the dominant country is China for linking inflation across these economies. The industrial production and inflation for each country is very closely linked in the long-run.