Macroeconomic factors and the Malawian Equity Market's Relationship: An analysis using Arbitrage Pricing Theory

Capital markets play a central role in the countries' economy. They act as a medium of channelling finances from surplus economic segments to the deficit ones. When there is growth in the equity markets, the entire economy is anticipated to advance. Moreover, the finance literature is rich in theoretical and empirical studies that support the notion that macroeconomic factors shape returns on capital markets. Thus this study steered by one of the financial theories in the name of Arbitrage Pricing Theory (APT) looked into the role of foreign exchange reserves, inflation and monetary policy rate on Malawi stock prices in the period January 2004-December 2018. The study adopted cointegration analysis, Vector Error Correction Model (VECM) and Granger causality so as to realise its intended purposes. The findings of this study signifies that the three mentioned macroeconomic conditions and Malawian equity prices are linked together in the long-run. Monetary policy rate holds a positive and significant long term interaction with equity returns whilst inflation exhibited a significant and a negative long-run linkage. As for foreign exchange reserve it also interacted with share indices negatively but did not possess any significance. In addition, inflation and foreign exchange reserves did not share any causal link with stock market returns. This is contrary to monetary policy rate which displayed a unidirectional causal link with equity indices running from the equity indices to monetary policy rate. The study's outcome has two implications (i) investors should not depend on the proclamation of the three macroeconomic factors when it comes to stock market investment making decisions in Malawi. (ii) Policies to extenuate inflation should be devised by Malawian authorities for the development of the stock market.