MACROECONOMIC VARIABLES IN MALAYSIA 219 [Asian Economic Journal 1998, Vol. 12 No. 3] 219 [Asian Economic Journal 1999, Vol. 13 No. 2] 219 Macroeconomic Variables and Stock Prices in Malaysia: An Empirical Analysis* Mansor H. Ibrahim International Islamic University Malaysia The article investigates the dynamic interactions between seven macroeconomic variables and the stock prices for an emerging market, Malaysia, using cointegra- tion and Granger causality tests. The results strongly suggest informational ineffi- ciency in the Malaysian market. The bivariate analysis suggests cointegration between the stock prices and three macroeconomic variables – consumer prices, credit aggregates and official reserves. From bivariate error-correction models, we note the reactions of the stock prices to deviations from the long run equilibrium. These results are further strengthened when we extend the analysis to multivariate settings. We also note some evidence that the stock prices are Granger-caused by changes in the official reserves and exchange rates in the short run. I. Introduction Establishing the lead-lag relationship between macroeconomic variables and stock prices is highly important. The significant lagged effects of macroeconomic variables on stock prices indicate informational inefficiency of the stock market. This means that individual investors can earn abnormal profits by exploiting past macroeconomic information. The presence of this exploitable opportunity would then seriously distort the market’s ability to efficiently allocate scarce resources. The reverse effects of stock prices on macroeconomic variables imply that stock market movements anticipate future economic conditions. Accordingly, they may be employed as a leading indicator in helping formulating current economic stabilization policies. While the causal nexus between these variables in developed economies is well documented, only a few studies have been conducted for emerging markets such as Malaysia. A recent notable study for the Malaysian market is that of Habibullah and Baharumshah (1996a). Applying residual-based cointegration tests, they find no evidence for cointegration between various stock indices, money * The comments made by an anonymous referee, which substantially improve the article, are highly appreciated. The usual disclaimer applies.