Abstract:
This paper investigated the impact of foreign direct investment (FDI) on the stock market performance in Sri Lanka by considering various control variables such as the gross domestic product (GDP) growth rate, interest rate, inflation rate, and exchange rate. The paper uses several approaches, such as Johansen cointegration, VECM, Granger causality tests, VDA, and IRF, to analyze the long-term and short-term equilibrium relationship, causal relations among the variables, and the influence of other variables’ shocks on the stock market using the quarterly data from 2003 to 2023. The results suggest a long-run equilibrium relationship exists between FDI and stock market performance. GDP growth reveals a negative and weak relationship with ASPI, while other factors show a positive relationship with the stock market. The short- and long-run results are different. In the short run, FDI did not significantly impact the performance of the Colombo Stock Exchange (CSE), but it negatively affected GDP growth. On the other hand, inflation had a positive effect on ASPI, although it was not significant in the short term. FDI shocks were constantly positive on ASPI. These results contribute to the literature by providing evidence that FDI may have the potential to influence long-term stock market growth in the Sri Lankan context. The study emphasizes the importance of creating a business-friendly environment to attract foreign investment and motivates investors to consider broader economic factors, such as inflation and interest rates based on research results.
