Abstract

The earnings-price ratio (E/P ratio) of the NSE Nifty index and the spreads between the E/P ratio and interest rates are widely used by market practitioners to forecast the stock market outlook. The present paper employs several statistical and econometric tools (viz., correlation analysis, regression analysis, Granger’s causality test and measures of out-of-sample forecast performance) for rigorously assessing the usefulness of spread in explaining stock market return in India. The database includes the weekly and monthly closing values of NSE Nifty index over the period January 5, 1997 to December 31, 2007 (11 years). The two measures of interest rate considered are Bank rate and call money rate. Empirical results reveal that spread seems to have reasonably strong causal influence on return and the causal model helps achieving forecasts slightly better than the random walk model.

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