Predictability of Stock price movements Evidence from the Amsterdam Stock Exchange Name: Yunis Lankarani Student number: 10826947 Supervisor: Drs. P.V.Trietsch, M.Phil. Study: BSc Economics and Business Track: Economics and Finance Number of credits thesis: 12 ECTS Statement of Originality This document is written by Yunis Lankarani who declares to take full responsibility of the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents. 2 Abstract This paper aims to answer the following research question: Can the price movements of the Amsterdam stock exchange price index be predicted using macroeconomic variables? The Arbitrage Pricing model is used to check the relationship in a monthly time series data over the period of 1983 - 2018. Five macroeconomic variables examined in this paper to predict the AEX index price movements are the interest rate, the exchange rate, industrial production, the CPI, and the money supply. Two statistical tests, namely, the Ordinary Least Squares (OLS) regression analysis and the Granger Causality test are applied to examine the relationship. The regression coefficients indicate that the exchange rate is positively and significantly related to the AEX price index. The interest rate, industrial production, the CPI, and the money supply coefficients match the expected hypothesis but insignificantly related to the AEX price index. The Granger Causality test concludes that at two variable lag level the exchange rate and the money supply are significant in forecasting the AEX price index. 3 Table of Contents Chapter 1: Introduction .................................................................................................................... 5 1.1 Motivation ............................................................................................................................... 5 1.2 Summary of Existing literature ................................................................................................ 5 1.3 Sub-questions .......................................................................................................................... 6 1.4 Data & Methodology ............................................................................................................... 6 1.5 Structure .................................................................................................................................. 7 Chapter 2: Literature Review ............................................................................................................ 8 2.1 Are stock price movements predictable according to the EMH? ............................................... 8 2.1.1 What is the EMH? ............................................................................................................ 8 2.1.2 How to test the EMH?....................................................................................................... 9 2.1.3 How efficient are the stock markets? ................................................................................. 9 2.2 Can Technical Analysis be used to predict stock price movements?........................................ 10 2.3 Which macroeconomic factors affect stock price movements?................................................ 10 2.3.1 Interest rate ..................................................................................................................... 12 2.3.2 Gross Domestic Product.................................................................................................. 13 2.3.3 Exchange rate ................................................................................................................. 13 2.3.4 Inflation rate ................................................................................................................... 14 2.3.5 Money supply ................................................................................................................. 14 Chapter 3: Data & Methodology ..................................................................................................... 16 3.1 Data & Descriptions............................................................................................................... 16 3.2 Methodology ......................................................................................................................... 18 Chapter 4: Data Analysis ................................................................................................................ 20 4.1 Unit Root test ........................................................................................................................ 20 4.2 Multicollinearity .................................................................................................................... 21 4.3 Regression Analysis ............................................................................................................... 22 4.4 Residual tests ......................................................................................................................... 23 4.4.1 Correlogram for Residuals .............................................................................................. 23 4.4.2 Heteroscedasticity test .................................................................................................... 24 4.4.3 Normality test ................................................................................................................. 24 4.5 Granger Causality Test .......................................................................................................... 25 Chapter 5: Conclusions .................................................................................................................. 27 5.1 Main findings ........................................................................................................................ 27 5.2 Limitations ............................................................................................................................ 28 5.3 Further research ..................................................................................................................... 28 REFERENCES............................................................................................................................... 30 APPENDIX .................................................................................................................................... 33 4 Chapter 1: Introduction 1.1 Motivation One of the fundamental issues in financial markets is understanding how firm characteristics and economic forces affect the stock price movements. Prediction of the stock price movements is an attempt to determine the firm value in the future on a stock exchange market. The successful prediction will result in future profits, which every investor desires. However, it is not an easy task, and some consider that it is not possible to beat the market because unexpected shocks affect the financial markets on a daily basis. There has been plenty of research done regarding the predictability of the stock prices. For instance, Campbell and Yogo (2006), attempted to determine whether the traditional regression methods used to test stock predictability were valid. The research on the predictability of monthly stocks prices by Kandel and Stambaugh (1996), stated that the statistical measures such as regression analysis are not strong enough to predict the future stock movements due to the efficiency and random walk of the stock market. The main focus of this research will be to answer the following question. Can the price movements of the Amsterdam stock exchange price index be predicted using macroeconomic variables? Predicting the stock price movements is testing whether the AEX price index is subject to the changes in the macroeconomic variables. This research is relevant since, Amsterdam Stock Exchange (AEX) with a market capitalization of 500 billion euros, and volume of 99,174,792 makes it the largest stock exchange market in the Netherlands (See Appendix figure 1 for the AEX Price Index graph). AEX is part of the Euronext stock exchange. Euronext is located in 6 countries Belgium, UK, Portugal, Ireland, France and the Netherlands. The headquarters are located in Amsterdam with a total market capitalization of 4649 billion USD. 1.2 Summary of Existing literature Whether reliable predictor variables of the stock prices exist is still a debate. Using the publicly available information to predict the stock price movements violates semi-strong form of the efficient market hypothesis. Several researchers have focused their studies on whether the efficient market hypothesis hold and the publicly available firm-specific information can help investors to predict the future stock price movements. For example, Keim and Stambaugh (1986) concluded that few observable firm-specific financial variables such as default risk, size of a firm are significantly related to the stock market price movements. Another research done by Pontiff and Schall (1998) indicated that the book to market ratio is significantly related to the future stock prices. According to Lewellen (2004), the book to market ratio, the dividend yield and the earnings-price ratio have a significant