2.

0-LITERATURE REVIEW:

2.1-Conceptual Review:

(Valev, 2011 ) Studied the impact of banking sector and stock markets on sources of economic

growth in high income countries and low income countries. The sources of economic growth in

terms of Capital accumulation and productivity were tested with respect to the Effects laid down

by Banks and Stock markets. It was concluded from tests that in low income countries Banks

tend to have a sizable impact over capital accumulation however Stock market had no significant

impact over capital accumulation, on the contrary in High income countries Banks as well as

Stock markets have their significance in capital accumulation. When productivity was tested it

was found neither banks nor stock markets had any significance in Productivity in low income

countries. In high income countries only Stock market had a significant role in productivity. All

these tests were carried out through generalized-method-of-moments (GMM) techniques.

Bano and Tabbada assumed that FDI flows from capital rich to capital scarce economies that is

from industrialized and developed countries to less industrialized and developing economies. A

new phenomenon has emerged named as “Reverse Flow of FDI”, that is FDI flow from the

developing and less industrialized economies to the developed and industrialized economies.

This is a continuation of process of globalization. (bano&tabbada, 2015)

(Anyanwu&Mijiyawa, 2012) have found negative relation between market seeking inflows of

FDI and trade openness. The reason of this relation is attributed to the tariff jumping theory

which MNEs that desire to serve local markets may take the decision to set up in host country a

subsidiary when it gets difficult to import things in the country.

Heckscher-Ohlin foundations based “Neoclassical Trade Theory” proposes that FDI flows will

be determined by differing factor returns to capital, particularly country level influences like

taxation, wage, relative interest, growth, wage and exchange rates which may assist in explaining

patterns of foreign direct investment. (crotti&cavoli&wilson, 2010)

(Ramos, 2009) analyzed the relation between Competition among stock markets and Stock

market development. Stock market development itself was found to be affected by various

factors and lack of work on this topic previous backings on financial development were used as

guideline. Ramos analyzed a huge data comprising of 101 stock markets and their data in time

series between 1975 to 2003 was used. An after complete study of the data it was concluded that

the divergence is mainly explained by changes in law and regulation enhancing competition. In

addition, the general level of competition is positively related with stock market development.

Competition causes a decrease in the transaction costs and the cost of capital, driving more firms

to list and more traders to trade. Results are consistent through time.

Eclectic paradigm is a theoretical framework and a famous conceptualization regarding the

determinants of foreign direct investment. This framework groups micro level and macro level

determinants in a way to examine that where and why multinational corporations invest. It says

that a firm seeks three advantages primarily; ownership, location and internalization. This is

called OLI framework. Advantages specific to Ownership like property rights, expertise, patents

etc. help a company to compete with other firms in the markets. Advantages of location adds to

the attraction of a foreign country more, like larger market size, labor advantages, barriers that

restrict imports, gains in trade costs. It may also arrive from differences in transport cost,

government regulations, natural endowments, cultural factors, macro-economic stability and

others. Internalization advantages come from the exploitation of imperfections in the external
markets, counting in the reduction of transaction cost and uncertainty in a way to engender

knowledge more effectively and efficiently and the lessening the imperfections generated by

state foreign exchange control, tariffs and subsidies. (Anyanwu&Yameogo, 2015)

(Chung, 2010)Investigates how foreign debt and foreign direct investment (FDI) affect the

growth and welfare of a stochastically growing small open economy. CHUNG broke research in

some steps. 1) In first step it is found that foreign debt influences the growth of domestic wealth

by lowering the cost of capital, while FDI affects the country’s welfare by providing an

additional source of permanent income. The second step concludes that a decline in domestic

investment may improve domestic welfare as FDI replaces the gap. 3rd step investigates that a

fiscal policy aimed to stabilize domestic output fluctuations needs to be conducted not to crowd

out the welfare benefit of FDI too much. In the final part it was finally concluded that an

economy with both types of foreign capital experiences wider welfare swings by external

volatility shocks than the one with foreign debt alone.

Previously studies have suggested that rising optimism caused by booming stock prices has a

significant negative impact on savings decisions. However, identifying this relationship clarifies

only one side of the problem. It is also necessary to look at whether savings decisions can affect

stock market performance. (Wu, 2012)Explores how these savings and stock market investment

decisions in the private sector can affect economic growth in China. Dayong Zhang & Yu Wu

applied vector auto-regression analysis over the time series data of China Stock Market

Accounting Research (CSMAR). The results concluded were as follow. 1) Savings and stock

investment decisions for Chinese private investors are consistent. 2) Households transfer money

from their bank accounts to the stock market when the stock market booms and withdraw from

the risky stock market to the banks when market conditions are weak. Investors in China,
especially most private investors, are apt to act like trend chasers. Results also suggest that the

opposite causality does not exist. Changes in household savings have no significant influence on

stock prices, and the variation of stock prices is almost independent from changes in savings.

2.2-Empirical Review:

In Kenya both long run and short run relationship between market based financial development

and economic growth was found significantly positive however, the study failed to find any

significant impact of bank-based financial development on economic growth either in short run

or in long run as per (Odhiambo, 2016). The relation was tested over data spreading from 1987

to 2008 in Kenya. ARDL Model test was used over time series data to conclude the stated results

in Kenya context of the relationship between financial development and economic growth.

Are foreign exchange and stock prices interrelated? Is the relation same in long run and short

run? What is the direction of this Relation? (Paul Alagidedea, 2011) Answered these questions

in context of some developed nations i.e. Japan U.K, Switzerland, Canada and Australia.

Granger causality test applied in both direction on all 5 nations and the results were divergent.

Causality from exchange rates to stock prices is found for Canada, Switzerland, and UK; weak

causality in the other direction is found only for Switzerland. The Hiemstra–Jones test is used to

examine possible non-linear causality and the results indicate causality from stock prices to

exchange rates in Japan and weak causality of the reverse direction in Switzerland.

The study done by Liargov and Skandalis test the notion by using an econometric model that

open markets of developing nations are likely to entice more FDI. The research focused on both

the dimensions of trade openness; openness to imports and export led growth. They found that
there exist a significant and positive relation between the variables FDI inflows and trade

openness. Other than openness, factors like exchange rate stability, political stability and market

size (measured by GDP) positively influences foreign direct investment. The size of the economy

is captured by GDP of that country. It has been seen that bigger markets appeal more FDI

inflows. (Liargovas&Skandalis, 2011)

(J Günther, 2016) Analyzed central and Eastern Europe to find the determinants that attracts the

FDI. This cover the data set of year 1994-2013 because the FDI inflows have been increased

constantly after 1990. The data have been carried from 14 countries of CEECs. The study shows

the relation of inward FDI flow and FDI inward stock (in euros) in relation with GDP, trade,

labor cost, distance, risk. Regression analysis was carried out to evaluate that the larger markets

is more attracted toward FDI and larger the source of economy larger will be the chances of FDI

has been rejected. The result shows that the FDI is attracted towards lower labor cost and

growing market. It also shows high default risk is not a barrier for FDI.

(singhania&gupta, 2011) investigated the determinants of FDI inflows in India. GDP (adjusted),

inflation rate and research and development were found to have significant measure of FDI

whereas openness, interest rates and money growth were found to be less significant. By

applying model of ARIMA, they found that GDP adjusted and inflation positively impacts the

FDI inflows. Though inflation should be under controlled, but some inflation in India was found

to be a good sign for attracting FDI in the country. If country’s GDP increases, companies

operating abroad are willing to be a part of the success story by investing in that economy.

Surprisingly, it was concluded that growth in scientific growth negatively impacts FDI.

Stock market and Exchange rates are major financial indicator of any country that are highly

affected by internal and external factors. (Wang, 2015) tried to verify the correlation that exists
in Stock market and Exchange rate in this era of globalization in both short run and long run.

Quarterly data of 29 countries ranging from 2000 to 2011 was used and Pooled Mean Group

(PMG) method to estimate the dynamic heterogeneous panel data model to verify any correlation

among the variables through. Wang concluded that stock market and the foreign exchange

market have a long-run co-integration relationship and in the short-run, the stock market and the

foreign exchange market are negatively correlated. It was also concluded using the error-

correction adjustment process, the long-run relationship between the two is positive.

Are the relationship among two variable similar in all contexts? In all region and all nations? The

relation between stock prices and exchange rates were tested in various condition by various

researcher similarly (Zheng Yanga, 2014) investigate causal relations between stock returns and

exchange rate changes in Asian perspective. Zheng Yanga applies the Granger causality test in

quantiles to investigate causal relations between stock returns and exchange rate changes for nine

Asian markets overtheperiod1January1997to16August2010. It was concluded that although the

causal effects of exchange rate changes on stock returns (or stock returns on exchange rate

changes) are heterogeneous across quantiles, however the overall research suggests that most

stock and foreign exchange markets are negatively correlated.

Several theoretical and empirical studies suggest that there is a significant linkage between

exchange rates and stock returns. However, a question still arises with respect to the direct

relationship between exchange rate volatility and stock market performance. What effect does

exchange rate volatility have on emerging markets’ stock market development? (Nasser, 2014)

attempts to answer this question by analyzing the effect of exchange rate volatility on stock

market capitalization in twelve emerging countries over the period 1980–2010. Log linear model

were developed for long- and short-run (a bounds testing approach to co-integration) for twelve
emerging economies over the period 1980–2010. Estimates from all models show that exchange

rate volatility has a significant effect on stock market development in both the short run and long

run in a majority of countries. It was also concluded that despite many similarities among

emerging economies the effect of exchange rate volatility on stock market development works

via each country’s specific structure and characteristics.

Under this Article South Asian context was taken into consideration to and the objectives of the

study were to study the role of Market size (GDP as determinant of Market size) and Exchange

rate in Attracting Foreign Direct Investment. The article focuses on exploring the role of

Economic freedom (Index of Economic Freedom by heritage foundation was the measure) in

attracting FDI and it also intends to investigate the dependency of FDI on market size, economic

freedom, exchange, etc. Multivariate Regression analysis was applied in order to check for the

dependency of variables on each other. Our Null Hypothesis that random effect model is

consistent is rejected whereas fixed effect estimators were considered most appropriate. A

significant positive relationship between market size and FDI was found after the statistical tests

an another significant positive relationship in Economic freedom and FDI was found out to be

true after going through the same sort of tests . On the other hand it was found that Exchange rate

and FDI were negatively related. One of the key finding we can extract from this study is that in

order to increase FDI inflow governments should tend to stabilize the currency more and more.

(Hassan, 2011 )

The main theme of this article was to determine the relationship among financial development,

stock market development and economic growth. The dependent variable was economic growth

and independent variables were stock market development and financial development. The

sample time was taken from 1980 to 2009 due to the fact it was an era of development of
financial and capital markets. The comprehensive dataset included data of 172 countries and nest

panel data structure from World Bank’s “World development indicators 2010”. Average values

of a well-defined panel data structure with cross sectional geographic region, income groups and

time series proxy measures from 1980 to 2009 were obtained to consider heterogeneity of cross-

countries and homogeneity of geographic region and income groups. Measure of economic

growth was GDP and the measures of (SMD) Stock market development were (SMC) Stock

market capitalization and stock market trading. Measures of Financial development were (DCPS)

Domestic credit to private sector, (DCBS) Domestic credit by banking sector and (GDS) Gross

Domestic Savings. Panel estimation with fixed period effects and Multivariate time series

models were used. It was found that GDP has a strong positive relationship with DCPS and GDS

but negatively to DCBS. A positive shock to GDS, SMC, and SMT has a significant positive

impact on GDP, while GDP responds negatively to innovation in M3. (Jung-Suk Yu, 2012)

In this article the relationship of foreign direct investment with respect to Ease of Doing

Business was studied carefully. The hypothesis for this Article was World Bank’s Ease of Doing

Business measure, will attract more foreign direct investment. For determining this relationship

the doing business measure (DBM) of World Bank was taken as a Variable and Data of FDI was

the other Variable which was also taken from the World Bank’s world development indicator

(WDI). It was concluded that World Bank’s Ease of Doing Business measure, will attract more

foreign direct investment. Using the Data on Large scale it was found that on average this

Hypothesis was correct. In depth analysis of data however revealed significant impact of this

effect was solely on the basis of how easy it would be to trade across border. Apart from this it

was also concluded that this effect was absent in worlds poorest and most eager for FDI regions.

It could be concluded that “Being in a cluster of countries with good trade regulation improves a
country’s ability to attract FDI, while being in neighborhood with bad general regulation (other

than trade) reduces a country’s ability to attract FDI.” (Gillanders, 2015).

In this article the main focus was on European countries which are above the transitional phase.

For the sample data Poland, Czech Republic. Slovenia and Hungary were the countries selected.

Monthly Data were taken (from Eurostat.; Index, 1995=100) of nominal stock market indices

and nominal bilateral exchange rates (denominated as domestic currency per US dollar unit (for

which time series data had to first be transformed). The ADF (Augmented Dickey Fuller) test

was used. The results show that significant links exist between the stock market index and the

foreign exchange rate for three countries, where for Poland, both long-term and short-term links

exist. The results of the analysis presented could be justified by high capital inflows—through

FDI inflows and portfolio investments—in these countries. Increased financial market

integration in Europe could be another reason. (Welfens, 2013)

The study revolves around the interrelationship of Volatility of Domestic Macroeconomic factors

and Volatility of Stock market in Indian Context. The data selected was from July 1996 to March

2013. Conditional volatility is determined using Univariate autoregressive model and

Multivariate model is applied to determine the Relationship of Stock market volatility and

Macroeconomic volatility. Macroeconomic variables namely output, foreign institutional

investments, exchange rate, short term and long-term interest rates, broad money supply,

inflation and stock market indices BSE (Sensex) and NSE (Nifty) are used for analysis. It was

concluded after in-depth analysis of data that the interdependency of not just stock market but all

financial market and the macroeconomic fundamentals in India is increasing. (Mahakud, 2015)

Inflation hedging and inflation illusion may happen to influence the REIT stock prices and the

author has been quite keen on testing this relationship. The author has focused on the relationship
of REIT’s dividend yield and expected inflation. 1980-2008 was the data time-frame on which

the study was conducted and the data was accessed from the Federal Reserve Bank of St. Louis.

REIT dividend yield is decomposed into three components (a long-run dividend growth rate, an

equity risk premium, and a mispricing term) and each component is examined relative to

expected inflation. Findings suggest a negative relationship between REIT stock prices and

expected inflation. The results show that changes in inflation explain a large share of the time

series variation of the mispricing term and dividend yield is positively related to expected

inflation in most cases. (Wu, 2012)

Co movements in stock returns of the emerging Indian equity market and developed equity

markets of US, UK, France Germany were looked upon in this study. The data used was monthly

data from April 1997 to March 2013 for examining the dependence structure of stock return co

movements of Indian and developed equity markets. After analyzing the data carefully the author

concluded that both the Indian and international stock market volatility factors are only

significant during the extreme economic contraction regime; however, the impacts are different.

While an increase in Indian stock market volatility increases the return co movements, the

situation in international stock market volatility is entirely opposite. High level stock volatility in

Indian market reflects a global economic downturn whereas high stock market volatility in

international markets fails to severely impact the Indian stock markets during regimes of

economic contraction. (Mandal, 2016).

This study is mainly concentrated on finding the determinants of FDI in India. The study dealt

with macroeconomic variables such as GDP, inflation, interest rate, patents, money growth and

foreign trade to establish the best fit relation which could explain the variation related to the FDI

inflows in India. The statistical technique used to determine this relation was the autoregressive
integrated moving average approach (ARIMA) but he author tested the variables for several

assumptions before applying this model. The data for the analysis was taken from the World

Bank’s Database starting from the year 1991 and ending up to 2008. It was found out that GDP,

inflation rate and scientific research have a significant impact on FDI inflows n India and that 63

percent of the variation in FDI inflows is explained by the ARIMA model used in this study the

rest 37 percent remains unexplained and needs to be explored further by including more

macroeconomic variables and widening the scope of the study (Monica Singhania, 2011).

(Ovidiu Stoica, 2014) attempted to analyze how the capital markets respond to the monetary

policy through the short-term interest rate shocks. This study has used structural vector error

correction model in an attempt to identify the stocks of permanent and transitory nature using the

monthly data for LIBOR three-month interest rate, three-month market rate, index prices,

industrial production and exchange rates. The CEE counties focused upon were Czech Republic,

Hungary, Latvia, Romania and Poland. The study has chosen the industrial production index and

exchange rate to capture more realistically the relationship between interest rates and stock

prices. Empirical evidence arrived to from the results of the statistical model used in this research

shows that countries having no monetary policy autonomy show a negative relationship between

LIBOR and both industrial production and stock market price indexes. This paper is useful for

policy-making because it analyses how effective is the transmission of monetary policy impulses

through interest rates.

The debate about the macroeconomic determinants of the stock market development has been

discussed in great detail in this article. This study was conducted based on the data spreading

over data spanning number of years ranging from 1974-2010. The study focused on assessing the
impact of economic growth, financial development, inflation, investment and trade openness on

stock market development. The data was obtained from the economic survey and international

financial statistics. Zivot-Andrews unit root test was applied for integrating properties of the

variables and the autoregressive lag bounds test. It was found that economic growth, financial

development, investment and inflation increased the stock market development while trade

openness had an adverse impact. Based on the results of this article the government should focus

more on trade openness to stimulate the stock market development because it is a major player in

increasing or decreasing it. (Muhammad Shahbaz, 2016)

Outward Foreign Direct Investment is a stone left unturned by many of the researchers, however,

(Murthy, 2015) headlined that it is in the nature of international relocation of production.

Economic development’s pattern can determine the pattern of the OFDI. Principal component

analysis is used to construct a group of component indices which are human resource,

infrastructure, labor, market, trade openness and resource to determine OFDI. The Data spans

over a period of 1990-2009. The data taken is for 20 countries and 20 years which means 400

different sets of data on which the analysis has been done. Empirical results indicated that the

developing countries outflow has not been growing significantly. Considering the top ten

countries infrastructure’s elasticity was found to be the greatest. Top ten countries showed a

decent growth rate of 8 percent. FDI outflow is now shifting towards developing countries with a

significant infrastructure base.

A study based on the Brazilian economy is put forward to explain the relation of high inflation

and interest rates with stock returns and took the data to be from 1986-2011. Brazil experienced

both the periods of high inflation and stability. The findings of the study highlight the fact that
that there is bidirectional relation between stock returns and inflation. Inflation is measured

through Comprehensive consumer price index and short term interest rate is measured by

interbank certificate of deposit rate. The findings suggest that a positive relationship exists

between stock returns and inflation. The results prove that interest rate shocks also have an effect

on future stock returns and inflation rates too. (Pimentel, 2014)

Ever wondered about how the exchange rates and stock prices interact in an economy? The study

is based on the data available from the ASEAN-5 countries from Jan 2000 to Aug 2013. The

study makes use of the Granger causality approach to check for cross-sectional dependency and

heterogeneity across nations. All the data from this study was gathered from DataStream. The

findings suggest that there is potential for contagion effects resulting from changes in market’s

sentiment. The results for Granger Causality test indicated that the two financial markets were

integrated. In Malaysia, Philippines and Thailand foreign exchange could be used to hedge

investments and in Indonesia stocks are used to edge for foreign exchange investment. (Chin-

Chia Liang, 2015)

(Koc, 2016) analyzed the relationship between exchange rates and stock market indices in

England, Turkey and Japan. The time varying causality test was the tool used for the purpose of

analysis. First structural breaks were determined through Kapetanois unit root test and then doing

the rest of the work with a time varying causality unit root test. The data used ranges from Jan

1990 to Apr 2013. Majority of the data is taken from Yahoo Finance for this study and indices

tapped were FTSE, NIKKEI and BIST. The most significant result gained from this study was

that local and global crises strengthen the causality relationship between the exchange rate and
stock market index. This study lacks the point that causality wasn’t separated in terms of positive

and negative shocks.

One of the major question about investment in stocks is that how much the market is sensitive to

interest rates and how much impact is created by inflation. This article focuses in the sensitivity

of the stock markets to real and nominal interest rates and rate of inflation. Stock prices have

been taken from S&P 500 index. The data taken was from Jan 2003 to Dec 2013 and the sample

size of the data is based on 132 observations. This research has focused on analyzing sector

portfolios which don’t show the big picture and the inflation rate is obtained from the CPI. OLS

regression is used to quantify the relation among variables. According to the statistical results

show that the sectoral returns highlight a considerable degree of exposure to all types of interest

rate risk. Empirical evidence suggests that role of interest rate is not homogenous at the sector

level. (Francisco Jareno, 2016).

(J Günther, 2016) Analyzed central and Eastern Europe to find the determinants that attracts the

FDI. This cover the data set of year 1994-2013 because the FDI inflows have been increased

constantly after 1990. The data have been carried from 14 countries of CEECs. The study shows

the relation of inward FDI flow and FDI inward stock (in euros) in relation with GDP, trade,

labor cost, distance, risk. Regression analysis was carries out to evaluate that the larger markets

is more attracted toward FDI and larger the source of economy larger will be the chances of FDI

has been rejected. The result shows that the FDI is attracted towards lower labor cost and

growing market. It shows that the high default risk is not a barrier for FDI.

(Yartey, 2010) It examine the institutional and macroeconomic determinants of stock market

development in emerging economics. It uses a data set of 42 countries. The data has been taken
from the year 1990-2014.there are 5 models used in it. In model 1 baseline regression shows the

result that bank credit, stock market liquidity, gross domestic investment, GDP per capita and the

lagged dependent variable are significant and have positive effects on stock market development.

In model 2 the results show that lagged capitalization ratio, GDP per capita, bank credit, gross

domestic investment and stock market value traded are all significant and positive. The square of

bank credit is again negative and statistically significant. In model 3 the effect of saving on stock

market is determine and the result shows the positive result but saving is statistically

insignificant in stock market development. Model 4 examine the impact of FDI on stock market

development.it shows positive result but also insignificant in explaining the growth of emerging

stock markets. The last model analyzed the effect of private capital flows on stock market. The

result is positive and significant. Increase in private capital flows increases the stock market

development by .25%

It analyzed the relation between stock price and exchange rate for countries South Africa and

Nigeria. This study is important because other studies before this fail to provide structural break

which could give misleading results and to determine the effect of international stock market on

the stock market of Africa. It cover the data set from the year 2003-2013 and the data is collected

from NSE and world federation Of Exchange. Conventional methodology shows that integration

exist in stock prices and exchange rates in Nigeria while no such relationship exists in South

Africa. The other result shows that the casualty runs from exchange to domestic stock price and

not from domestic stock price to exchange rate in Nigeria. (Fowowe, 2015)
(Sudipta Basu, 2010) Examined from Michigan survey of consumer in the course of 1985-95 and

1995-2005, that whether analysts fully incorporate the factor of expected inflation to predict SUE

(standardized unexpected earning). Overall results show that analysts do not fully incorporate the

effect of expected inflation in their earnings forecast. The results to how we estimate inflation in

sub period analyses (1990-95) controlling for macroeconomic variables such as real interest rate,

industrial production growth, and investor sentiment. One possible answer is that analysts are

irrational, in that they frame the forecasting problem too narrowly and ignore information that

does not relate directly to the firm. Another explanation, more consistent with analysts behaving

rationally, is that the cost of fully incorporating expected inflation information exceeds the

monetary benefits from improved accuracy because inflation information should be more salient

and relevant to macroeconomic strategists, this study suggests other promising avenues for future

research. In general, prices faced by a firm in its input and output markets are more relevant for

forecasting its earnings than prices from markets in which a firm does not participate

(D. Ramjee Singh, 2008) This is an attempt to present empirical evidence in order to ascertain

some of the factors that would influence the flow of FDI into small developing countries. The

results of this analysis undertaken from 135 countries including 13 Caribbean states revealed that

several of the traditional variables, i.e., infrastructure, economic growth and openness to trade,

do promote the flow of FDI to small developing nation states. The paper, further, revealed that

the size of a country's market is not a major constraint in attracting FDI because this limitation

can be overcome by actively promoting the inflow of export or extractive oriented FDI, through

the creation of a competitive policy framework and provide a domestic environment that will
allow local firms to compete in international markets. The study also brings into focus the

importance of tourism, among small countries, as an important source of FDI.

‘
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