IS THE STOCK MARKET IN THE PHILIPPINES A LEADING INDICATOR OF ECONOMIC ACTIVITY?

Abstract

The conventional models for stock pricing are anchored on the assumption that current stock prices are forward looking as they reflect the estimated future earnings of firms.  Since expectations of future earnings are influenced directly by the expected level of economic activity, then fluctuations in stock prices today may predict the future growth and direction of the economy. The purpose of this study is to empirically investigate whether the theoretical proposition that stock prices are a leading indicator of economic activity applies to a small open economy like the Philippines. The nexus between stock prices and the real economy is explored using the Granger causality technique based on the vector error correction model (VECM) using quarterly data from 1995 to 2017. The findings indicate the existence of a statistically significant positive long run relationship between real stock price and real economic growth. The econometric tests further demonstrate that in the short run, real stock price Granger causes real gross domestic product (RGDP). This provides evidence that changes in current stock prices may predict changes in future economic activity lending support to the leading indicator role of the stock market in the Philippines in the short run.  However, in the long run, a unidirectional causality from RGDP to real stock price is likewise detected suggesting that economic growth contributes to the development of the country’s stock market over the long term.

Keywords

• Stock Prices,Economic Growth,Granger Causality

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