European Journal of Social Sciences – Volume 14, Number 3 (2010)

The Effects of Macroeconomics Variables on Stock Returns:

Evidence from Turkey

Ahmet Büyükşalvarcı
Department of Business, University of Selcuk, Konya, Turkey
E-mail: asalvarci@selcuk.edu.tr
Tel: +90 507 379 29 49

Abstract
The aim of this paper is to analyze the effects of macroeconomic variables on the Turkish
Stock Exchange Market in the Arbitrage Pricing Theory framework. This study embraces
seven macroeconomic variables (consumer price index, money market interest rate, gold
price, industrial production index, oil price, foreign exchange rate and money supply) and
the main Turkish stock market Index (Istanbul Stock Exchange Index-100). The data are
monthly and extend from the January of 2003 to the March of 2010. A multiple regression
model is designed to test the relationship between the ISE-100 Index returns and seven
macroeconomic factors. The results of the paper indicate that interest rate, industrial
production index, oil price, foreign exchange rate have a negative effect on ISE-100 Index
returns while money supply positively influence ISE-100 Index returns. On the other hand,
inflation rate and gold price do not appear to have any significant effect on ISE-100 Index
returns.

Keywords: Arbitrage Pricing Theory, Macroeconomic Variables, Stock Returns, Turkish

Stock Exchange

1. Introduction
Capital markets play an important role in the financial sector of each economy. An efficient capital
market can promote economic growth and prosperity by stabilizing the financial sector and providing
an important investment channel that contributes to attract domestic and foreign capital. Capital market
efficiency means the unanticipated portion of the return on a security is unpredictable, and over a
sufficient number of observations, does not differ systematically from zero. The unanticipated portion
is the actual return less what was expected based on some fundamental analysis.
According to Fama (1970), a market is efficient if prices rationally, fully, and instantaneously
reflect all relevant available information and no profit opportunities are left unexplained. In an efficient
market, past information is of no use in predicting future prices and the market should react only to
new information. However, since this is unpredictable by definition, price changes or returns in an
efficient market cannot be predicted.
Fama (1970) also defined market efficiency in the forms of weak, semi-strong, or strong. The
weak-form of market efficiency means the unanticipated return is not correlated with previous
unanticipated returns, thus the market has no memory and knowledge of past returns, and they have no
bearing on determining future returns. Semi-strong market efficiency means market returns are not
correlated with any publicly available information. And lastly, with the strong-form of market
efficiency, the unanticipated return is not correlated with any information be it public or insider since
all available information is already being reflected in present returns.

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In modern portfolio theory, the mean variance Capital Asset Pricing Model (CAPM) has
become the major analytic tool for explaining the relationship between the expected return and risk.
The CAPM, an equilibrium model for the price determination of risky assets, was developed by Sharpe
(1964), Lintner (1965) and Mossin (1966) and extended by Huberman (1982), and Chamberlain and
Rothschild (1983). Quite a few empirical studies (e.g. Gibbons (1982), MacKinlay (1987), Reinganum
(1981), Lakonishok and Shapiro (1986) and Coggin and Hunter (1985)) have revealed abnormal
returns inconsistent with equilibrium in a market where the CAPM holds. Therefore, these empirical
findings suggest that there are other factors which account for the portion of security returns not
captured by beta.
The Arbitrage Pricing Theory (APT) developed by Ross (1976) was proposed as an alternative
to the CAPM. The APT is similar to the CAPM in that it is also an equilibrium model. However, the
APT is more general than the CAPM since it allows the equilibrium returns of assets to be dependent
on many factors, not just one (e.g., beta). The APT assumes that the return on asset is a linear function
of various macroeconomic factors or theoretical market indices, where sensitivity to changes in each
factor is represented by a factor-specific beta coefficient. The APT states that the realized return on
asset is composed of the expected return on that asset at the beginning of a time period and the
unexpected realization of k risk factors during that time period plus firm specific risk.
The aim of this paper is to analyze the effects of macroeconomic variables on the Turkish Stock
Exchange Market in the APT framework. Istanbul Stock Exchange Index-100 (ISE-100) is analyzed
based on monthly data from January 2003 to March 2010 by seven macroeconomic fundamental
indicators. The macroeconomic variables used in this study are consumer price index, money market
interest rate, gold price, industrial production index, oil price, foreign exchange rate and money supply.
In the analyses of time series, multi linear regression method was used. The remainder of the paper is
organized as follows: Section 2 provides information about the ISE; Section 3 reviews the related
literature; Section 4 explains the data and methodology; Section 5 reports the empirical results; the
final section provides conclusions.

2. History of the Istanbul Stock Exchange (ISE)

The origin of an organized securities market in Turkey has its roots in the second half of the 19th
century. The first securities market in the Ottoman Empire was established in 1866 under the name of
"Dersaadet Securities Exchange" following the Crimean War. Dersaadet Exchange also created a
medium for European investors who were seeking higher returns in the vast Ottoman markets.
Following the proclamation of the Turkish Republic, a new law was enacted in 1929 to reorganize the
fledgling capital markets under the new name of "Istanbul Securities and Foreign Exchange Bourse".
Soon, the Bourse became very active and contributed substantially to the funding requirements
of new enterprises across the country. However, its success was clouded by a string of events,
including the Great Depression of 1929 and the impending World War II abroad which had taken their
toll in the just developing business world in Turkey. During the industrial drive of the subsequent
decades, there was a continuous increase in the number and size of joint stock companies, which began
to open up their equity to the public. Those mature shares faced a strong and growing demand from
mostly individual investors and some institutional investors.
The early phase of the 1980s saw a marked improvement in the Turkish capital markets, both in
regard to the legislative framework and the institutions required to set the stage for sound capital
movements. In 1981, the "Capital Market Law" was enacted. The next year, the main regulatory body
responsible for the supervision and regulation of the Turkish securities market, the Capital Markets
Board based in Ankara, was established. A new decree was issued in October 1983 foreseeing the
setting up of securities exchanges in the country. In October 1984, the "Regulations for the
Establishment and Functions of Securities Exchanges" was published in the Official Gazette. The
regulations concerning operational procedures were approved in the parliament and the Istanbul Stock

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Exchange (ISE) was formally inaugurated on 26 December 1985 but began its operations on 3 January
1986.
The ISE is the only securities exchange in Turkey established to provide trading in equities,
bonds and bills, revenue-sharing certificates, private sector bonds, foreign securities and real estate
certificates as well as international securities. The ISE is a dynamic and growing emerging market with
an increasing number of publicly traded companies, state-of-the-art technology and strong foreign
participation. The ISE provides a transparent and fair trading environment not only for domestic
participants, but also for foreign issuers and investors.
The National Market is the major component of the ISE. There are also Regional, New
Companies, and Watch-List Companies Markets. Most of the firms (89.72%) are traded at the National
Market. At the end of 2009, 288 firms are listed in National Market, 20 firms in Second National
Market, 2 firms in New Economy Market, 11 firms in Watch-List Companies Market. Table 1 provides
figures showing the developments of ISE in last twenty-four years.

Table 1: Developments in ISE from 1986 to 2009

Traded Number of Stocks

Year Number of Firms Traded Value (Million $)
(Thousand)
1986 80 13 3
1987 82 118 15
1988 79 115 32
1989 76 773 238
1990 110 5.854 1.537
1991 134 8.502 4.531
1992 145 8.567 10.285
1993 160 21.770 35.249
1994 176 23.203 100.062
1995 205 52.357 306.254
1996 228 37.737 390.924
1997 258 58.104 919.784
1998 277 70.396 2.242.531
1999 285 84.034 5.823.858
2000 315 181.934 11.075.685
2001 310 80.400 23.938.149
2002 288 70.756 33.933.251
2003 285 100.165 59.099.780
2004 297 147.755 69.614.651
2005 304 201.763 81.099.503
2006 317 229.642 91.634.552
2007 326 300.842 116.814.185
2008 321 261.274 114.793.157
2009 321 316.326 205.986.913
Source: www.ise.org

As seen in Table 1, the number of listed companies, trading volume and traded value has
increased significantly from 1986 to 2009. The number of companies traded on the exchange climbed
from 80 at the end of 1986 to 321 at the end of 2009. Another noticeable growth is observed in the
trading value, which has sharply increased from only US$ 13 million in 1986, to over US$ 316 billion
in 2009.
The listing requirements for the securities presenting partnership are regulated by both the ISE
and the Capital Market Board. To get the listing of a security at exchange, the following conditions are
required: the number of shareholders must be above 100; at least 15% of the paid-in capital must have
been publicly offered; at least 3 years must have elapsed since the incorporation date. The exchange
administration normally determines and approves a financial structure, which must be at a level to

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enable the company to carry out its activities. The firm is also required to show a profit in the previous
2 consecutive years.
ISE price indices are computed and published throughout the trading session while the return
indices are calculated and published at the close of the session only. 44 indices are computed for the
stock market. The indices are: ISE National-All Shares Index, ISE National-30, ISE National-50, ISE
National-100, sector and sub-sector indices, ISE 10 Banks Index, ISE Corporate Governance Index,
ISE City Indices, ISE Second National Market Index, ISE New Economy Market Index and ISE
Investment Trusts Index. The ISE National-100 Index contains both the ISE National-50 and the ISE
National-30 Index and is used as a main indicator of the national market.

3. Review of Literature
Many authors have tried to show reliable associations between macroeconomic variables and stock
returns. They identified several key macroeconomic variables which influenced stock market returns
based on the Arbitrage Pricing Theory (APT). A brief overview of the studies focusing on developed
and emerging capital markets is presented in this section.
Chen, Roll and Ross (1986) was the first study to select macroeconomic variables to estimate
U.S. stock returns and apply the APT models. They employed seven macroeconomic variables,
namely: term structure, industrial production, risk premium, inflation, market return, consumption and
oil prices in the period of Jan 1953-Nov 1984. In their research, they found a strong relationship
between the macroeconomic variables and the expected stock returns during the tested period. They
note that industrial production, changes in risk premium, twists in the yield curve, measure of
unanticipated inflation of changes in expected inflation during periods when these variables are highly
volatile, are significant explaining expected returns. They found that consumption, oil prices and
market index are not priced by the financial market. They conclude asset prices react sensitively to
economic news, especially to unanticipated news.
Burmeister and Wall (1986) continued down a similar path of research laid down by Chen, Roll
and Ross (1986). Having conducted previous research suggest that the variability of stock returns could
be explained by unanticipated changes in certain macroeconomic variables mainly: unanticipated
change in term structure, unanticipated change in inflation, unanticipated change in the risk premium
and unanticipated change in asset return but they suggest more research was needed. In addition,
Abdullah and Hayworth (1993) observed that the U.S. stock returns are related positively to inflation
and growth in money supply, yet negatively to budget and trade deficits, and also to short and long
term interest rates.
Poon and Taylor (1991) parallel the Chen, Roll and Ross (1986) study on the United Kingdom
market. Their results show that macroeconomic variables do not appear to affect share returns in the
United Kingdom as they do in the U.S. They suggest that either different macroeconomic factor have
an influence on share returns in the United Kingdom or the methodology employed by Chen, Roll and
Ross (1986) is inefficient.
On the other hand, Clare and Thomas (1994) investigate the effect of 18 macroeconomic factors
on stock returns in the U.K. They find oil prices, retail price index, bank lending and corporate default
risk to be important risk factors for the U.K. stock returns. Priestley (1996) prespecified the factors that
may carry a risk premium in the U.K. stock market. Seven macroeconomic and financial factors;
namely default risk, industrial production, exchange rate, retail sales, money supply unexpected
inflation, change in expected inflation, terms structure of interest rates, commodity prices and market
portfolio. For the APT model, with the factor generating from the rate of change approach all factors
are significant.
For Japanese stock market, Hamao (1988) replicated the Chen, Roll and Ross (1986) study in
the multi-factor APT framework. He put on view that the stock returns are significantly influenced by
the changes in expected inflation and the unexpected changes in both the risk premium and the slope of

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the term structure of interest rates. Through the APT, Brown and Otsuki (1990) explore the effects of
the money supply, a production index, crude oil price, exchange rates, call money rates, and a residual
market error on the Japanese stock market. They observe that these factors are associated with
significant risk premium in Japanese equities.
Maysami and Koh (2000) tested the relationships between the Singapore stock index and
selected macroeconomic variables over a seven-year period from 1988 to 1995 and they found that
there existed a positive relationship between stock returns and changes in money supply but negative
relationships between stock returns with changes in price levels, short- and long-term interest rates and
exchange rates.
To examine the interdependence between stock markets and fundamental macroeconomic
factors in the five South East Asian countries (Indonesia, Malaysia, Philippines, Singapore, and
Thailand) was the main purpose of Wongbangpo and Sharma (2002). Monthly data from 1985 to 1996
is used in this study to represent GNP, the consumer price index, the money supply, the interest rate,
and the exchange rate for the five countries. Their results showed that high inflation in Indonesia and
Philippines influences the long-run negative relation between stock prices and the money supply, while
the money growth in Malaysia, Singapore, and Thailand induces the positive effect for their stock
markets. The exchange rate variable is positively related to stock prices in Indonesia, Malaysia, and
Philippines, yet negatively related in Singapore and Thailand.
Mahmood and Dinniah (2009) examined the dynamics relationship between stock prices and
economic variables in six Asian-Pacific selected countries of Malaysia, Korea, Thailand, Hong Kong,
Japan and Australia. The monthly data on stock price indices, foreign exchange rates, consumer price
index and industrial production index that spans from January 1993 to December 2002 are used. In
particular, they focused their analysis on the long run equilibrium and short run multivariate causality
between these variables. The results indicate the existing of a long run equilibrium relationship
between stock price indices and among variables in only four countries, i.e., Japan, Korea, Hong Kong
and Australia. As for short run relationship, all countries except for Hong Kong and Thailand show
some interactions. The Hong Kong shows relationship only between exchange rate and stock price
while the Thailand reports significant interaction only between output and stock prices.
Tan, Loh and Zainudin (2006) look at the dynamic between macroeconomic variables and the
Malaysian stock indices (Kuala Lumpur Composite Index) during the period of 1996-2005. They found
that the inflation rate, industrial production, crude oil price and Treasury Bills’ rate have long-run
relation with Malaysian stock market. Results indicate that consumer price index, industrial production
index, crude oil price and treasury bills are significantly and negatively related to the Kuala Lumpur
Composite Index in the long run, except industrial production index coupled with a positive
coefficient.
Bailey and Chung (1996), examine the impact of macroeconomic risks on the equity market of
the Philippines. Findings of the study show that, financial fluctuations, exchange rate movements and
political changes on owners of Philippine equities cannot explain Philippine stock returns.
Mohammad, Hussain and Ali (2009) examine the relationship between macroeconomics
variables and Karachi Stock Exchange in Pakistan context. They have used quarterly data of foreign
exchange rate, foreign exchange reserve, gross fixed capital formation, money supply, interest rate,
industrial production index and whole sales price index. The result shows that exchange rate and
exchange reserve and highly affected the stock prices.
Niarchos and Alexakis (2000) investigated whether it is possible to predict stock market prices
with the use of macroeconomic variables in the Athens Stock Exchange. Macroeconomic variables
include inflation, money supply and exchange rate. The time period under investigation was from
January 1984 to December 1994 on a monthly basis. The statistical evidence suggests that monthly
stock prices in the Athens Stock Exchange are positively correlated to those variables.
A research by Kandir (2008) can be considered an example of the APT testing in Istanbul Stock
Exchange. He investigates the role of seven macroeconomic factors in explaining Turkish stock returns

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in the period from July 1997 to June 2005. Macroeconomic variables used in his study are growth rate
of industrial production index, change in consumer price index, growth rate of narrowly defined money
supply, change in exchange rate, interest rate, growth rate of international crude oil price and return on
the MSCI World Equity Index and the analysis is based on stock portfolios rather than single stocks.
His empirical findings reveal that exchange rate, interest rate and world market return seem to affect all
of the portfolio returns, while inflation rate is significant for only three of the twelve portfolios. On the
other hand, industrial production, money supply and oil prices do not appear to have any significant
affect on stock returns. His findings also suggest that macroeconomic factors have a widespread effect
on stock returns, since characteristic portfolios do not seem to be influenced in a different manner by
the macroeconomic variables.
Tursoy, Gunsel and Rjoub (2008) is another example of the APT test in Turkish stock market.
They tested the APT in Istanbul Stock Exchange for the period of February 2001 up to September 2005
on monthly base. They tested 13 macroeconomic variables (money supply, industrial production, crude
oil price, consumer price index, import, export, gold price, exchange rate, interest rate, gross domestic
product, foreign reserve, unemployment rate and market pressure index) against 11 industry portfolios
of Istanbul Stock Exchange to observe the effects of those variables on stocks’ returns. Using ordinary
least square technique, they observed that there are some differences among the industry sector
portfolios.

4. Data and Methodology

4.1. Data Description and Variable Definitions
The aim of this study is to explain the effects of macroeconomic variables on the stock returns in
Turkey using monthly data from January 2003 to March 2010. Istanbul Stock Exchange-100 Index is
used as a proxy for the performance of the Turkish stock market. Seven macroeconomic variables, that
are hypothesized to influence stock returns, are examined. These macroeconomic variables are
consumer price index, money market interest rate, gold price, industrial production index, international
crude oil price, foreign exchange rate and broad money supply.
The dependent variable used is Istanbul Stock Exchange-100 Index (ISE-100) returns. It is
calculated by using following equation:
Rt = ln( Pt ) − ln( Pt −1 ) (1)
Where; Ri is return for month t , Pt and Pt −1 are closing values of ISE-100 Index for month t
and t − 1 respectively. The source used for the dependent variable was Central Bank of Republic of
Turkey.
The data for the explanatory variables, namely consumer price index, money market interest
rate, gold price, industrial production index, foreign exchange rate and broad money supply is obtained
from the database of Central Bank of Republic of Turkey while international crude oil price data come
from International Financial Statistics (IMF).

4.2. Explanatory Variables and Hypotheses

4.2.1. Consumer Price Index (CPI)
Consumer Price Index is used as a proxy of inflation rate. CPI is chosen as it is a broad base measure to
calculate average change in prices of goods and services during a specific period. Inflation is ultimately
translated into nominal interest rate and an increase in nominal interest rates increase discount rate
which results in reduction of present value of cash flows so it is said that an increase in inflation is
negatively related to equity prices. An empirical studies by Chen, Roll and Ross (1986), Barrows and
Naka (1994), Mukherjee and Naka (1995) and Wongbangpo and Sharma (2002) conclude that inflation
has negative effects on the stock market. Nonetheless, as price stability is one of the macroeconomic

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policy objectives by the Turkish government and also an expected target of the Turkish citizens, we
believe that the effect of inflation on stock price is insignificant.
Hypothesis 1: There isn’t any significant effect of consumer price index on ISE-100.

4.2.2. Money Market Interest Rate (MIR)

One-month time deposit rate is used as a proxy of money market interest rate. The intuition regarding
the relationship between interest rates and stock prices is well established, suggesting that an increase
in interest rates increases the opportunity cost of holding money and thus substitution between stocks
and interest bearing securities and hence falling stock prices. Thus, a change in nominal interest rates
should move asset prices in the opposite direction. Maysami and Koh (2000), Tan, Loh and Zainudin
(2006) and Kandir (2008) found a negative sign.
Hypothesis 2: There is a negative effect of money market interest rate on ISE-100.

4.2.3. Gold Price (GLD)

Bullion price is used as a proxy of gold price. Gold is an alternative investment tools for Turkish
investors. As the gold price rises, Turkish investors tend to invest less in stocks, causing stock prices to
fall. Therefore, a negative relationship is expected between gold price and stock returns.
Hypothesis 3: There is a negative effect of gold price on ISE-100.

4.2.4. Industrial Production Index (IPI)

Industrial Production Index is used as proxy to measure the growth rate in real sector. Industrial
production presents a measure of overall economic activity in the economy and affects stock prices
through its influence on expected future cash flows. Chen, Roll and Ross (1986), Mukherjee and Naka
(1995), Ibrahim and Aziz (2003) found a positive sign. Thus it is expected that an increase in industrial
production index is positively related to stock returns.
Hypothesis 4: There is a positive effect of industrial production index on ISE-100.

4.2.5. Oil Price (OIL)

Brent oil price is used as proxy for oil price. Turkey is a net importer of oil; therefore, oil price play an
important role in Turkey economy. For oil importer countries, an increase in oil price will lead to an
increase in production costs and hence to decreased future cash flow, leading to a negative impact on
the stock market.
Hypothesis 5: There is a negative effect of oil price on ISE-100.

4.2.6. Foreign Exchange Rate (FEX)

In this study end of month US Dollars/Turkish Lira exchange rate is employed as foreign exchange
rate. Turkey is an import dominated country. For an import dominated country; currency depreciation
will have an unfavorable impact on a domestic stock market. As the Turkey’s currency depreciates
against the U.S. dollar, products imported become more expensive. As a result, if the demand for these
goods is elastic, the volume of imports would increase, which in turn causes lower cash flows, profits
and the stock price of the domestic companies. Ibrahim and Aziz (2003) found a negative sign. Thus, a
negative relationship is expected between foreign exchange rate and stock returns.
Hypothesis 6: There is a negative effect of foreign exchange rate on ISE-100.

4.2.7. Money Supply (M2)

Broad Money (M2) is used as a proxy of money supply. Increase in money supply leads to increase in
liquidity that ultimately results in upward movement of nominal equity prices. Mukherjee and Naka
(1995), Maysami and Koh (2000) found a positive sign. Therefore, a positive relationship is expected
between money supply and stock returns.
Hypothesis 7: There is a positive effect of money supply on ISE-100.

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Before the empirical analysis, all explanatory variables explained above are converted to a
monthly continuous increase rate by taking their first logarithmic differences:
G (Vi )t = ln (Vi )t − ln (Vi )t −1 (2)
Where; G (Vi )t is the continuous growth (change) of variable i month t . (Vi )t and (Vi )t −1 are the
level of variable i for month t and t − 1 respectively.

4.3. Econometric Model

Different methods have been employed to test the relationships between macroeconomic variables and
stock prices. This study examined the effects of macroeconomic variables on ISE-100 index by using a
multiple regression model. This model was useful and suitable because the research focus lied in
examining the contemporaneous relationships between stock returns and changes in macroeconomic
variables.
Based on both theoretical and empirical literature reviewed, this study hypothesize the model
between ISE-100 index (ISE) and seven macroeconomic variables, namely consumer price index
(CPI), money market interest rate (MIR), gold price (GLD), industrial production index (IPI),
international crude oil price (OIL), foreign exchange rate (FEX) and money supply (M2). The
hypothesized model is represented as follows:
ISE = f (CPI , MIR, GLD, IPI , OIL, FEX , M 2 ) (3)
In order to see whether the above identified macroeconomic factors could explain ISE-100
index returns, the multiple regression model is formed:
ISEt = β 0 + β 1CPI t + β 2 MIRt + β 3 GLDt + β 4 IPI t + β 5 OILt + β 6 FEX t + β 7 M 2 t + ε t (4)
In the above equation β 0 is constant and β is coefficient of variables while ε t is the residual
error of the regression. The ordinary least squares (OLS) method is used to compute the estimates of
the regression model stated above and all estimations have been performed in the econometrical
software program EViews 5.1, whereas the ordinary calculations in Excel.

5. Empirical Results
Various descriptive statistics are calculated of the variables under study in order to describe the basic
characteristics of these variables. Table 2 presents the descriptive statistics of the data, containing
sample means, medians, maximums, minimums, standard deviations, skewness, kurtosis as well as the
Jarque-Bera statistics and probabilities (p-values).

Table 2: Descriptive Statistics of Study Variables

ISE CPI MIR GLD IPI OIL FEX M2

Mean 0.0187 0.0007 -0.0127 0.0116 -0.0008 0.0101 -0.0012 0.0154
Median 0.0191 0.0071 -0.0028 0.0139 -0.0048 0.0234 -0.0078 0.0135
Maximum 0.1724 0.0256 0.2248 0.1795 0.2238 0.2502 0.1808 0.0908
Minimum -0.2772 -0.0073 -0.2093 -0.1265 -0.2129 -0.4544 -0.0878 -0.0294
Std. Dev. 0.0790 0.0071 0.0474 0.0509 0.0836 0.1159 0.0392 0.0206
Skewness -0.6717 0.2752 0.2357 0.2839 -0.0495 -1.0270 1.6517 0.9166
Kurtosis 4.2709 2.7015 12.4320 4.1985 3.5452 5.5002 8.3292 5.9687
Jarque-Bera 12.1129 1.3887 315.9296 6.2294 1.0873 37.0791 139.2345 43.1172
Probability 0.0023* 0.4994 0.0000* 0.0444 0.5806 0.0000* 0.0000* 0.0000*
Observation 86 86 86 86 86 86 86 86
Note: Asterisk (*) denotes the null of normality was rejected at 1% significance level.

As it can be seen from the Table 2, all the variables are asymmetrical. More precisely, skewness
is positive for five series, indicating the fat tails on the right-hand side of the distribution comparably
with the left-hand side. On contrary, ISE, IPI and OIL have a negative skewness, which indicates the
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fat tails on the left-hand side of the distribution. Kurtosis value of all variables also shows data is not
normally distributed because values of kurtosis are deviated from 3. The calculated Jarque-Bera
statistics and corresponding p-values are used to test for the normality assumption. Based on the
Jarque-Bera statistics and p-values this assumption is rejected at 1 percent level of significance for all
variables, with the only three exceptions being the monthly variables in CPI, GLD and IPI. So the
descriptive statistics shows that the values are not normally distributed about its mean and variance or
other word we can says no randomness in data and therefore, being sensitive to speculation shows
periodic change. This indicated that individual investor can earn considerably higher normal rate of
profit from the Istanbul Stock Market. So the results of above descriptive statistics raise the issue the
inefficiency of market. The funds of market are not allocated to the productive sector of the economy.
One of the basic assumptions of Ordinary Least Square (OLS) method is that regressors are not
mutually correlated. If more than one of them is correlated with other, multicollinearity is said to exist.
Logic behind assumption of no multicollinearity is simple that if two or more independent variables are
linearly dependent on each other, one of them should be included instead of both. In order to check
multicollinearity among independent variables, a correlation analysis has been performed. A suggested
rule of thumb is that if the pair wise correlation between two regressors is very high, in excess of 0.8,
multicollinearity may pose serious problem. The correlation analysis results are reported in Table 3.
Since the highest correlation numbers are lower than 0.8, the results clearly show that none of the
independent variables are highly correlated and no multicollinearity amongst independent variables
exist.

Table 3: Pearson Coefficient of Correlation Matrix

CPI MIR GLD IPI OIL FEX M2

CPI 1
MIR 0.064292 1
GLD 0.310714 -0.142287 1
IPI 0.0036774 -0.028674 0.113995 1
OIL -0.132111 -0.170425 -0.080906 0.044237 1
FEX 0.269277 0.291028 0.537952 0.079565 -0.304555 1
M2 0.003420 -0.006772 0.412403 0.153225 -0.190213 0.409842 1

Most macroeconomic time series data are often assumed to be non-stationary and thus it is
necessary to perform a pretest to ensure there is a stationary cointegrating relationship among variables
to avoid the problem of spurious regression. Before proceeding with the OLS estimations, it is
necessary to investigate the time series properties of the variables by utilizing unit root tests. The
Augmented Dickey-Fuller (ADF) (Dickey and Fuller, 1979; 1981) and Phillips-Perron (PP) (Phillips
and Perron, 1988) unit root tests have been performed in this study in order to check whether the time
series are stationary or not. The ADF and PP unit root tests results are presented in Table 4. The
optimal lag lengths for the ADF test were chosen based on the Schwarz Information Criterion (SIC),
while for the PP test, it is based on the automatic selection procedure of Newey-West (1994) for
Bartlett Kernel.

Table 4: Unit Root Test Results (ISE-100 Index and Macroeconomic Variables)

ADF Unit Root Test (at level) PP Unit Root Test (at level)
Variables Intercept Trend and Intercept Intercept Trend and Intercept
ISE -6.836004* (0) -6.844574* (0) -6.823720* (2) -6.829561* (2)
CPI -7.063283* (0) -7.019714* (0) -7.187228* (12) -7.108168* (12)
MIR -5.922254* (0) -5.979582* (0) -5.889129* (2) -5.897419* (3)
GLD -7.127243* (0) -7.178430* (0) -7.029812* (4) -7.074678* (4)
IPI -8.147378* (10) -8.081770* (10) -12.22153* (3) -12.60732* (2)
OIL -7.536928* (0) -7.494260* (0) -7.526939* (1) -7.483615* (1)

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FEX -7.222316* (1) -7.351448* (1) -6.144043* (7) -6.156860* (8)
M2 -9.276278* (0) -9.228944* (0) -9.312872* (2) -9.281899* (3)
Notes: 1. PP is the Phillips-Perron and ADF is the Augmented Dickey-Fuller test.
2. Asterisk (*) indicates rejection of the null hypothesis of non-stationary at the 1% level.
3. The proper lag order for ADF test is chosen by considering Schwarz Information Criterion (SIC), and white noise
of residuals, representing in parenthesis.
4. For PP tests, the bandwidth is chosen using Newey–West method and spectral estimation uses Bartlett kernel,
representing in parenthesis.
5. MacKinnon (1996) critical values are used for ADF and PP tests. The 1%, 5% and 10% critical value for the ADF
and PP tests is -3.51 and -2.89 and -2.59 for intercept and -4.07, -3.46 and -3.16 for trend and intercept
respectively.

As it can be seen from the Table 4, in the levels form both tests results clearly show that the
null hypothesis of the existence of a unit root is rejected at 1% significance levels in the examined time
series, all of the series are accepted not to contain unit root. More precisely, the hull hypothesis of a
unit root can be rejected in both the ADF and PP tests, because the test statistics are more negative than
the critical values and therefore t-statistics are lying in the rejection of the null area. Having concluded
that all of the series are stationary, the effect of macroeconomic variables on the ISE-100 index returns
is examined by Ordinary Least Square (OLS) estimation. OLS estimation results using Newey-West
autocorrelation estimator are reported in Table 5.

Table 5: Regression Analysis Result (Dependent Variable: ISE)

Variables Coefficient Std. Error t-Statistic Probability

Constant 0.005748 0.009238 0.622242 0.5356
CPI 0.118972 0.657051 0.181070 0.8568
MIR -0.310092 0.181382 -1.709606 0.0914***
GLD -0.206744 0.191005 -1.082400 0.2825
IPI -0.098923 0.050670 -1.952291 0.0546***
OIL -0.127957 0.043410 2.947654 0.0043*
FEX -1.034275 0.203693 -5.077621 0.0000*
M2 0.518399 0.264688 1.958527 0.0538***
R2 0.515659
Adjusted R2 0.471049
Durbin-Watson 2.013741
F-Statistic 11.55919
Prob(F-statistic) 0.000000
Note: Asterisks (*) and (***) indicates significance at 1% and 10% respectively.

As Table 5 reports that the values of adjusted R Square (0.471049) suggest that model serves its
purpose in determining the effect of macroeconomic variables on stock price index. In other words,
47.11% variability of the stock price index return can be explained by the consumer price index (CPI),
money market interest rate (MIR), gold price (GLD), industrial production index (IPI), oil price (OIL),
foreign exchange rate (FEX), money supply (M2). Before analyzing the coefficients, one should look
at the diagnostics of regression. In this matter, Durbin-Watson (DW) statistic can show us the serial
correlation of residuals. As a rule of thumb, if the DW statistic is less than 2, there is evidence of
positive serial correlation. The DW statistic in our output is 2.013741 and this result confirms that there
is no serial correlation. With computed F-value of 11.55919 (p<0.000) for the OLS regression, we
reject the null that all coefficients are simultaneously zero and accept that the regression is significant
overall.
According to the test results, consumer price index (CPI) does not have any effect on ISE-100
index returns at 10% significant level. This means that the market evaluates inflation figures nearly
correct before the announcement of the actual rate. This is not surprising since as specified before price
stability is one of the macroeconomic policy objectives by the Turkish government and also an
expected target of the Turkish citizens.
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As expected, interest rate (MIR) has a significant and negative effect on ISE-100 index returns.
This indicates that interest rate represents alternative investment opportunities. As the interest rate
rises, investors tend to invest less in stocks, causing stock prices to fall.
Gold price (GLD) does not seem to be a significant factor for ISE-100 index returns. This
statistical insignificance is surprising, since gold is another alternative investment tools for Turkish
investors.
An interesting point in the results of the study is the relationship observed between industrial
production index and ISE-100 index returns. The effect of industrial production index (IPI) on ISE-100
index returns is statistically significant as expected, but with the wrong sign.
As expected, oil price (OIL) is negatively related to ISE-100 index returns and significant at 1%
level. This result indicates that in Turkey, oil is important factor in determining the production cost of
the firms.
The relationship between exchange rates and stock prices was hypothesized to be negatively
related, showing that a depreciation of the Turkish currency in terms of US Dollars would have a
favorable impact on the Turkish stock market. This relationship was found to exist between exchange
rate (FEX) and ISE-100 index returns at 1% significant level.
Money supply (M2) has a significant and positive effect on ISE-100 index returns. Changes in
money supply would alter the money market equilibrium or would impact real economic variables,
thus affect stock returns. According to the test results, in Turkish case, changes in money supply
appear to influence both the equilibrium in the financial asset markets and the real economic variables.
Thereby, money supply appears to be related with Turkish stock returns.
To sum up our results, money market interest rate (MIR), industrial production index (IPI), oil
price (OIL), foreign exchange rate (FEX) and money supply (M2) seem to effect the Istanbul Stock
Index-100 (ISE-100) returns. On the other hand, consumer price index (CPI) and gold price (GLD) do
not appear to have significant effects on stock returns.

5. Conclusions
Many studies have been conducted to explore the variation of financial markets to macroeconomic
variables theoretically and empirically. Some of these studies have focused on the relationship between
stock market prices and fundamental economic activities. The outcome of these studies varies greatly
regarding the effect of changes of macroeconomic variables on stock prices. Some of these studies
found that changes in macroeconomic variables lead the changes in stock markets and that stock prices
can be predicted by means of publicly available information such as time series data on financial and
macroeconomic variables.
The main objective of the present paper is to explain the effect of macroeconomic variables on
the stock returns in Turkey using monthly data from January 2003 to March 2010. Istanbul Stock
Exchange-100 Index (ISE-100) is used as a proxy for the performance of the Turkish stock market.
Seven macroeconomic variables, that are hypothesized to influence stock returns, are examined. These
macroeconomic variables are consumer price index, money market interest rate, gold price, industrial
production index, international crude oil price, foreign exchange rate and broad money supply.
A multiple regression model is designed to test the relationships between the ISE-100 index
returns and seven macroeconomic factors. In the regression models, the ISE-100 index returns are used
as dependent variables, while the macroeconomic variables are used as independent variables. The
results of the paper indicate that interest rate, industrial production index, oil price, foreign exchange
rate have a negative effect on ISE-100 Index returns, while money supply positively influence ISE-100
Index returns. On the other hand, inflation rate and gold price do not appear to have any significant
effect on ISE-100 Index returns.

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