17 Academy of Accounting and Financial Studies Journal, Volume 11, Number 3, 2007 COINTEGRATION AND CAUSALITY BETWEEN STOCK INDEX AND MACROECONOMIC VARIABLES IN AN EMERGING MARKET Tantatape Brahmasrene, Purdue University North Central Komain Jiranyakul, National Institute of Development Administration ABSTRACT This study examined the relationship between stock market index and selected macroeconomic variables during the post-financial liberalization (pre-financial crisis) and post- financial crisis in Thailand. In the empirical analysis, unit root, cointegration and Granger causality tests were performed. The post-financial liberalization results showed that the stock market index, the industrial production index, money supply, exchange rate, and world oil prices contained a unit root and were integrated of order one. Johansen cointegration test was then employed. The results showed at least one cointegrating or long-run relation between the stock market index and a set of macroeconomic variables. Money supply had a positive impact on the stock market index while the industrial production index, the exchange rate and oil prices had a negative impact. During the post-financial crisis, all variables were integrated at different orders. Cointegration existed between the stock market index and macroeconomic variables. In addition, the Granger causality test indicated money supply was the only variable positively affecting the stock market returns. INTRODUCTION The Stock Exchange of Thailand has been considered an emerging stock market since its inauguration in April 1975. The market capitalization of Thailand Stock Exchange is small while bond trading and other financial innovations have emerged in just the last few years. Like other emerging stock markets in Asia, liberalization in the Thai financial markets, both money and capital markets, reduced the regulation for foreign investors who were interested in investing in Thailand. The financial liberalization in 1992 included lifting capital control measures and allowing banks to lend and borrow more freely in both in- and off-shore transactions. In addition, the Thai government urged capital inflows in both portfolio and foreign direct investment. As a result, the volume of stock trading increased substantially in recent years. Equity instruments are a crucial source of funds for business firms. A continuous increase in private investment via issuing new stocks can be a conduit of GDP expansion and, thus, a high employment rate.