Abstract:
The purpose of this study is to investigate the relationship between stock return volatility,
political uncertainty, macroeconomic variables and output. Why does stock volatility
increase when output declines? Theory of investment under uncertainty implies that
political uncertainty may simultaneously increase volatility and reduce output. Though
the basic facts are well-established, the causal link between volatility and business
slumps is unclear. Slumps may cause volatility, volatility may cause slumps, or both may
be the consequence of some other more clearly exogenous factors.
The study examines the explanatory power of the selected variables to explain the
output over a period from 1998 to 2003 using multiple regression approach. Monthly
secondary data are gathered from Colombo Stock Exchange, Central Bank of Sri Lanka,
Elections Department and Department of Police. Eight important variables have been
identified for the study namely, stock return volatility, changes in share price, political
uncertainty, inflation rate, exchange rate and treasury bill rate. Descriptive statistics and
regression analysis were carried out to analyze the data. Regression analysis was
carried out for the periods before and after the peace process.
The results of the study show that three variables indicate a significant impact on the
output. Study indicates two general conclusions. First, the existence of stock return
volatility, share price changes and political uncertainty affect the output. Second, the
existence of such environments i.e., politically uncertain and volatile stock market
reveals that some unexplained factors affect the output. However, political uncertainty
hypothesis is not statistically significant but the coefficients are negative as assumed in
the valuation model. However, taking all the variables together in the model explains
more than moderate level change in output.
