An Empirical Test of the Arbitrage Pricing Theory: The Case of Dhaka Stock Exchange (DSE)

Abstract

This study empirically tested Arbitrage Pricing Theory (APT) in the Dhaka Stock Exchange [DSE) using five macroeconomic variables namely money supply, index of industrial production, crude oil price, remittance, and foreign exchange reserves. Monthly data from January 2013 to June 2021 was employed in the empirical analysis. The study adopted the Autoregressive Distributed Lag (ARDL) Model and Granger causality test. The long-run ARDL results indicate that none of the selected macroeconomic variables have statistically significant influence on stock return in the long term. Except for remittances, the other four variables are positively related to the stock return of DSE. The divergence of remittance may be attributed to its predominant allocation toward household consumption, land acquisition and other non-equity investments. In the short run, money supply and crude oil price have significant and positive impact on stock return while the other variables have insignificant effects. The study suggests that 118% of the disequilibrium in the return of DSE is adjusted monthly to get back to the long-run equilibrium. The Granger causality test result revealed a bi-directional causality between stock return and money supply and a unidirectional causality running from industrial production index, crude oil price, and remittances to stock return while another unidirectional causality running from the stock return to foreign exchange reserves. Overall, the findings of the results suggest that APT is valid in the DSE in the short run but not applicable in the long run.