The Sri Lankan stock market and the macroeconomy: an empirical investigation

Purpose The purpose of this paper is to examine the causal relationships between stock prices and macroeconomic variables in Sri Lanka, in order to examine the validity of the semi‐strong form of the efficient market hypothesis. Design/methodology/approach The paper adopts unit roots and cointegration, error‐correction modelling, variance decomposition analysis, and impulse responses analysis to examine the causal relationship between six macroeconomic variables. Findings The results indicate that there are both short and long‐run causal relationships between stock prices and macroeconomic variables. These findings refute the validity of the semi‐strong version of the efficient market hypothesis for the Sri Lankan share market and have implications for investors, both domestic and international. Originality/value The paper addresses several methodological weaknesses in relation to unit root and cointegration tests which previous studies in the area of the paper have overlooked. Further, it uses more variables than those used in a previous study using Sri Lankan data.