Title: Is the relationship between macroeconomy and stock market liquidity mutually reinforcing? Evidence from an emerging market

Authors: Ijaz Ur Rehman; Nurul Shahnaz Mahdzan; Rozaimah Zainudin

Addresses: Faculty of Business and Accountancy, Department of Banking and Finance, University of Malaya, Kuala Lumpur 50603, Malaysia ' Faculty of Business and Accountancy, Department of Banking and Finance, University of Malaya, Kuala Lumpur 50603, Malaysia ' Faculty of Business and Accountancy, Department of Banking and Finance, University of Malaya, Kuala Lumpur 50603, Malaysia

Abstract: This study investigates whether macroeconomic variables and stock market liquidity have any impact on each other in an emerging market. The Granger causality test and innovative accounting approach (IAA) are used to test the causality among the variables of interest over the period of 2000 M₁-2014 M₁₂. Our results suggest that in the short-run, monetary base, interest rate, inflation and foreign equity net inflow have a lagged impact on stock market liquidity. The causality analyses suggest that only industrial production and foreign equity net inflow cause stock market liquidity. The IAA approach suggests that shocks to inflation and foreign equity net inflow increase stock market illiquidity while positive shocks to industrial production decrease stock market illiquidity. Our results suggest weak evidence of feedback from stock market liquidity to macroeconomic variables.

Keywords: monetary policy; business cycles; foreign equity net inflow; stock market liquidity; order-driven markets; macroeconomic variables; emerging markets; monetary base; interest rates; industrial production; stock markets.

DOI: 10.1504/IJMEF.2016.078405

International Journal of Monetary Economics and Finance, 2016 Vol.9 No.3, pp.294 - 316

Received: 28 May 2015
Accepted: 15 Jul 2015
Published online: 16 Aug 2016 *

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