Journal of Financial Economic Policy

Canonical correlation analysis: Macroeconomic variables versus stock returns

Peter Mazuruse

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Canonical correlation analysis

Macroeconomic variables versus stock returns

Canonical
correlation
analysis

Peter Mazuruse
Harare Institute of Technology, Harare, Zimbabwe

179

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Abstract
Purpose The purpose of this paper was to construct a canonical correlation analysis (CCA) model for
the Zimbabwe stock exchange (ZSE). This paper analyses the impact of macroeconomic variables on
stock returns for the Zimbabwe Stock Exchange using the canonical correlation analysis (CCA).
Design/methodology/approach Data for the independent (macroeconomic) variables and
dependent variables (stock returns) were extracted from secondary sources for the period from January
1990 to December 2008. For each variable, 132 sets of data were collected. Eight top trading companies
at the ZSE were selected, and their monthly stock returns were calculated using monthly stock prices.
The independent variables include: consumer price index, money supply, treasury bills, exchange rate,
unemployment, mining and industrial index. The CCA was used to construct the CCA model for the
ZSE.
Findings Maximization of stock returns at the ZSE is mostly influenced by the changes in consumer
price index, money supply, exchange rate and treasury bills. The four macroeconomic variables greatly
affect the movement of stock prices which, in turn, affect stock returns. The stock returns for Hwange,
Barclays, Falcon, Ariston, Border, Caps and Bindura were significant in forming the CCA model.
Research limitations/implications During the research period, some companies delisted due to
economic hardships, and this reduced the sample size for stock returns for respective companies.
Practical implications The results from this research can be used by policymakers, stock market
regulators and the government to make informed decisions when crafting economic policies for the
country. The CCA model enables the stakeholders to identify the macroeconomic variables that play a
pivotal role in maximizing the strength of the relationship with stock returns.
Social implications Macroeconomic variables, such as consumer price index, inflation, etc.,
directly affect the livelihoods of the general populace. They also impact on the performance of
companies. The society can monitor economic trends and make the right decisions based on the current
trends of economic performance.
Originality/value This research opens a new dimension to the study of macroeconomic variables
and stock returns. Most studies carried out so far in Zimbabwe zeroed in on multiple regression as the
central methodology. No study has been done using the CCA as the main methodology.
Keywords Stock returns, Macroeconomic variables, Canonical correlation, Canonical variates,
Canonical loadings, Redundancy index
Paper type Research paper

1. Introduction
The study of macroeconomic variables and their impact on stock returns has been an
area of intense interest among academics, investors and stock market regulators since
the 1970s. The relationship between macroeconomic variables and stock returns affects
the valuation of securities and risk management. Because the inter-dependence of the
JEL classification C51, C61

Journal of Financial Economic Policy

Vol. 6 No. 2, 2014
pp. 179-196
Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-09-2013-0047

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180

stock market and the real economy is very strong, it means that any movement in stock
prices directly affects the real economy. It is vital to determine what drives the volatility
of both the fixed-income securities and stock prices, as this can assist in predicting the
path of economic growth. For investors, volatility implies holding more securities in
portfolios so as to achieve diversification. That is why macroeconomists and finance
specialists are increasingly focusing on the relationship between macroeconomic
variables and stock returns. Researchers, such as Aftab (2000), Fazal etal (2001), Nishat
(2004), Shahaz (2006) and Sharma (2007), have extensively researched on the
relationship between macroeconomic variables and stock returns. The fundamental
differences from their findings are that they selected different types of variables in their
research. The number of variables they used also differed. The researchers concentrated
mostly on developed and emerging markets, ignoring developing markets like
Zimbabwe. Methodologies that were used were different, and conclusions that were
drawn somehow differed. This research seeks to broaden the subject to developing
markets like Zimbabwe. It seeks to consider those macroeconomic variables that
directly affect stock returns at the Zimbabwe Stock Exchange (ZSE). The canonical
correlation analysis (CCA) was used to analyse the data. This methodology is a complete
deviation from the multiple regression which is usually applied. Thus, the motive is to
determine the macroeconomic variable sensitivities to stock price movements at the
ZSE.
Since the formation of the ZSE in 1896 in Bulawayo, policymakers, stock market
regulators, investors and stock market analysts have relied on the supply and demand
model in pricing assets and calculating stock returns, disregarding other determinants
of stock returns like macroeconomic variables. Macroeconomic variables provide a
platform for a detailed analysis of stock returns because they influence the performance
of the overall economy. Probably a macroeconomic variable approach to stock market
returns may fill the gap being left by the supply and demand theory approach currently
in use. The results for the research can be used for decision-making.
The research seeks to unveil a working strategy for policymakers, investors and fund
managers on how best to structure investment portfolios for the maximization of stock
returns. It aims to come up with a prescription for the treatment of macroeconomic
variables so that they positively impact the stock market returns for the benefit of the
Zimbabwean economy. Thus, the research seeks to construct an optimization model for
ZSE using the CCA.
The theoretical and practical motivation for undertaking this research on stock
returns and stock market forces can be discussed as follows.
An efficiently operating stock market ensures economic growth and prosperity. It
helps in the diversification of domestic funds and their channelling into productive
investments. To achieve this, the stock market should have a significant relationship
with macroeconomic variables. Nowadays, the capital market has become a key element
of a market-based economy. It transfers the long-term funds from savers to borrowers of
capital, which is very essential for economic development. After globalization,
international capital markets are being integrated rapidly. This integration positively
affects economic growth by reducing the contagious effect of risk on financial assets.
A well-performing stock market positively affects economic activities through
growth, saving and the efficient allocation of investment. Such an economy attracts
foreign direct investment. The stock market can boost the confidence of savers by

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providing domestic households with investment funds. The efficient market hypothesis
(EMH) suggests that all the relevant information to investors about profit maximization
is reflected through stock prices and macroeconomic variables (Chong, 2003). If EMH is
implemented in stock markets, the role of stock brokerage firms diminishes gradually.
The stock market plays the vital role of transferring funds from capital borrowers to
capital investors. This is very essential for economic growth. It increases liquidity of
financial assets and diversification of global risk. This enables investors to make wiser
investment decisions (Agrawalla, 2006).
The research also seeks to broaden research previously carried out on this subject.
Previous researchers concentrated mostly on developed and emerging markets, leaving
out developing markets like Zimbabwe. The methodologies used by previous
researchers concentrated on multiple regression analysis, ignoring other methodologies
such as the CCA. A research of this nature has practical implications on policymakers,
stock market regulators, investors and stock market analysts in Zimbabwe.
2. Literature review
The literature review is divided into two categories: the first review focuses on research
carried out on stock returns versus macroeconomic variables with the CCA as the
modelling tool. The second review focuses on general studies that were carried out on
the relationship between stock returns and macroeconomic variables using other
methodologies.
After 1986, the relationship between macroeconomic factors and stock returns was
extensively investigated. The findings from literature point to the existence of a
significant link between macroeconomic factors and stock returns in the countries
examined. Arnold (1996) applied CCA to explore the relationship between security
returns and economic factors in international settings, namely, the UK and the USA. The
CCA was applied in investigating a set of economic indicators that synthetically
influence security returns. The results showed that the CCA successfully links the stock
market and the economic factors. Azhar (2006) used the CCA, the principal components
analysis and the generalised least squares to determine the arbitrage pricing factors
in the Malaysian Stock Exchange. The CCA results suggest that macroeconomic
variables and stock market returns are significantly correlated at principal
component scores of the macroeconomic variables, namely, FECONI (0.4470),
FECON2 (0.3214) and FECON3 (0.7791). The results suggest that FECON1 represents
the macroeconomic variables such as the US exchange rate, the Singapore exchange rate
and Money supply (M2). The FECON2 represents macroeconomic variables such as
export, import, industrial index and gold production. FECON3 represents
macroeconomic variables such as oil prices (petroleum) and the Japanese exchange rate.
Sabetfar et al. (2011) carried out a study on the Tehran Stock Exchange (1991-1998).
They wanted to find out the common risk factors in the returns of non-oil-based stocks
in the Tehran Stock Exchange using the principal component analysis, the
cross-sectional regression and the CCA. The research results showed that the 13
macroeconomic variables which were used failed to fully explain excess returns of the
samples. All the 13 macroeconomic variables did not affect stock market returns.
Fan Fah et al. (2010) used the CCA to test the arbitrage pricing theory on the Tehran
Stock Exchange. Tests conducted using the principal component analysis showed that
at least one to three factors can explain the cross-section of expected returns in this

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market. The results suggest that there are four groups of macroeconomic variables in
the test period (1991-2008) that affect stock returns. But the significance of these factors
was found to be inconsistent over time. In general, the findings document a weak
applicability of the arbitrage pricing theory in this market.
Vuyyuri (2005) investigated co-integration relationship and the causality between
the financial and real sectors of the Indian economy using monthly observations from
July 1992 to December 2002. The financial variables used were interest rate, inflation
rate, stock returns and industrial production (proxy for real economy). The augmented
Dickey Fuller and Phillips Perron unit root tests were applied to check for
stationarity. The Granger test showed unidirectional Granger cause between the
financial and the real sector of the economy.
Afzal (2011) carried out an empirical analysis of the relationship between
macroeconomic variables and stock prices in Bangladesh using co-integration and the
Granger causality test. The results suggest that co-integration exists between stock
prices with money supply values, M1 and M2, and inflation rate. This indicates the
existence of a long-run relationship between them. Unidirectional causality was found to
exist from the stock market to the exchange rate, M1 and M2. Cakmarh et al. (2010) found
that macroeconomic variables have useful information for predicting monthly US
excess stock returns and volatility over the period 1980-2005 using linear regression
models.
Chen et al. (1986) tested the multifactor model in the USA by using seven
macroeconomic variables. They found that consumption, oil prices and market index
were not priced by the financial market. However, industrial production, changes in risk
premium and twists in the yield curve were significant in explaining stock returns. Chen
(1991) performed the second study covering the USA. Research findings showed that
future market stock returns could be forecasted by interpreting macroeconomic
variables such as default spread, term spread, one-month treasury-bill rate, industrial
production growth rate and the dividend price ratio. Clare et al. (1994) investigated the
effect of 18 macroeconomic factors on stock returns in the UK. They found that oil prices,
retail price index, bank lending and corporate default risks were important risk factors
for the UK stock returns. Mukherjee and Naka (1995) used the vector error correction
approach to model the relationship between the Japanese stock returns and
macroeconomic variables. A co-integration relation was detected among stock prices
and the six macroeconomic variables, namely, exchange rate, long-term government
bond rate and call money rate. Gjrde and Saettem (1999) examined the causal relation
between stock returns and macroeconomic variables in Norway. Results showed that a
positive link exists between oil price, real activity and stock returns. However, the study
failed to show a significant relationship between stock returns and inflation.
A recent study by Flannery and Protopapadakis (2002) re-evaluated the effect of
some series announcements on stock returns. Among these series, six macroeconomic
variables, namely, balance of trade, housing starts, employment, consumer price index,
money supply and producer price index affected stock returns. On the other hand, two
popular measures of aggregate economic activity (real gross national product [GNP] and
industrial production) were not related to stock returns.
Bailey and Chung (1996) examined the impact of macroeconomic risks on the equity
market of Philippines. Findings of the study showed that financial fluctuations,
exchange rate movements, political changes and equity cannot explain Philippine stock

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returns. Mokerjee and Qiao (1997) investigated the effect of macroeconomic variables on
the Singapore Stock Exchange market. Results suggest that stock prices co-integrated
with both measures of the money supply (M1 and M2) and aggregate foreign exchange
reserves. However, stock prices and exchange rates did not have a long-term
relationship. Ibrahim and Aziz (2003) investigated the relationship between stock prices
and industrial production, money supply, consumer price index and exchange rate in
Malaysia. Stock prices were found to share a positive long-run relationship with
industrial production and consumer price index. On the contrary, stock prices have a
negative association with money supply and the Ringgit exchange rate. Cheung and Ng
(1998) investigated the relationship between stock prices and some macroeconomic
factors, namely, real oil prices, total personal consumption, money supply (M1) and GNP
in Canada, Germany, Italy, Japan and the USA. Results showed that there is a long-run
co-movement between the selected macroeconomic variables and real stock market
prices. Billson and Hooper (2001) used value-weighted world market index and some
macroeconomic variables for explaining stock returns in selected emerging markets.
Findings showed that goods prices and real activity have limited ability to explain the
variation in return. Sharma et al. (2002) investigated the relationship between stock
prices and some macroeconomic factors in five Asian countries, namely, Indonesia,
Malaysia, Philippines, Singapore and Thailand. Results suggest that in the long run,
stock prices will be positively related to growth and output. In the short run, stock prices
are found to be functions of past current values of macroeconomic variables.
3. Research methodology
3.1 Data collection
The data used in this research were sourced from the Central Statistics Office, ZSE, Old
Mutual Asset Managers Zimbabwe (Private) Lt. and the Reserve Bank of Zimbabwe.
Top trading companies (counters) were selected because there was delisting and listing
of companies during the period under study due to harsh economic conditions. Those
counters which remained listed during the period under study were considered because
they had enough sets of data needed for the research. The counters selected were
categorized into two groups, namely, the industrial and the mining. The industrial
group consists of Ariston Holding Limited (Ariston), Border Timbers Limited (Border),
Barclays Bank of Zimbabwe Limited (Barclay), CAFCA Limited (Cafca) and Caps
Holding Limited (Caps). The mining group consists of Bindura Nickel Corporation
Limited (Bindura), Falcon Gold Zimbabwe Limited (Falcon) and Hwange Colliery
Company Limited (Hwange). These were the top eight movers at the ZSE during the
study period, and they never delisted from ZSE.
The data collected from Central Statistics Office included: industrial and mining
indices, inflation rate, money supply rate and unemployment rate. Prior to 1993, the
Central Statistics Office produced a Consumer Price Index for high-income urban
families and another for low-income urban families. This was later revised with an
overall Consumer Price Index calculated from 1993 onwards. Because of hyperinflation
between 2005 and 2008, the research omitted data during that period. Data during that
period could distort the research findings. This was the reason for not considering the
period prior to 1994 in the study because the overall index is difficult to derive, given
that two indices were available. Data for money supply, exchange rate and interest rate
(91 days Treasury bill rate) were gathered from the Reserve Bank of Zimbabwe. The

Canonical
correlation
analysis
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184

secondary data gathered have data on 12 cases, 11 time periods, for a total of 132
observations. The study combined data gathered through discussion, arbitration and
abstraction to shed light on the main theme of the problem being investigated. The CCA
was used to analyse the data. Data on stock returns were deduced from stock prices for
each counter. The return from buying and holding a stock depends on the price at the
time of purchase, holding period, total dividend payments received and price at the end
of the holding period. Given Pit, the price for the ith asset for month is t and dit is the
dividend paid to stock i in the tth month, then the rate of return for asset i in the tth month
is given by:

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Rit

Pit Pi(t1) dit

Pit Pi(t1)
dit

Pi(t1)
Pi(t1)
Pi(t1)

(3.1)

The equation (3.1) is the sum of the capital gain yield and dividend gain yield. Assuming
that investors have not declared any dividend on the exchange market, the cash
dividend declared is zero, and, as a result, the equation (3.1) is reduced to:
Rit

Pit Pi(t1)
Pi(t1)

(3.2)

Equation (3.2) was used to convert raw asset prices to the rate of return. The mean return
N
Rt,R, subtracted from Rit to get a zero return, and R was the
R calculated by 1 / N t1
adjusted return obtained from the transformation process.
3.2 Model building: the theory behind
3.2.1 CCA (hotelling). This is a multivariate technique of measuring the linear
relationship between two multidimensional variables. It can be thought of as multiple
multiple regression. It finds two bases, one for each variable that are optimal with
respect to correlations. At the same time, it finds the corresponding correlations. In other
words, it finds the two bases in which the correlation matrix between the variables is
diagonal and correlations on the diagonal are maximized. The dimensionality of these
new bases is equal to or less than the smallest dimensionality of the two sets of variables.
Mathematically:
Consider the following two equations:
W1 a11X1 a12X2 a1pXp

(3.3)

V1 b11y1 b12y2 b1qyq

(3.4)

Where W1 is a linear combination of the X variables.

V1 is the linear combination of the y variables.
Let C1 be the correlation between W1 and V1.
The objective of canonical correlation is to estimate a11, a12 [] a1p and b11, b12 []
b1q such that C1 is maximized. Equations (3.3) and (3.4) are canonical equations, W1 and
V1 are the canonical variates and C1 is the canonical correlation. Once W1 and V1 have
been estimated, the next step is to identify another set of canonical variates:

W2 a21X1 a22X2 a2pXp

V2 b21y1 b22y2 b2qyp

(3.5)

such that the correlation C2 between them is maximum. W2 and V2 are uncorrelated with
W1 and V1, i.e. the two sets of canonical variates are uncorrelated. This procedure is
continued until the mth set of canonical variates;

Canonical
correlation
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Wm am1 am2X2 ampXp

Vm am1y1 bm2y2 bmqyq

(3.6)

In summary, the objective of canonical correlation is to identify the m sets of canonical

variates, (W1, V1), (W2, V2) [] (Wm, Vm), such that the corresponding canonical
correlations C1, C2 [], Cm are maximum and Corr (Vj, Vk) 0, for all j k, Corr (Wj,
Wk) 0, for all j k.
Cor (Wj, Vk) 0, for all j k. This is clearly an optimization/maximization problem
subject to certain constraints. Fitting the overall model is done using redundancy
analysis.
3.2.2 Redundancy analysis. Relying on the canonical correlations alone on
significance testing is quite misleading. Thus, another test called the redundancy
analysis is carried out for both the dependent and the independent variables. This
overcomes the inherent bias and uncertainty in using canonical roots (squared canonical
correlations) as a measure of shared variance. The redundancy index is calculated by
squaring multiple correlation coefficients between the total independent variable set
and each variable in the dependent variable set, and then averaging these squared
coefficients to get an average R2 value.
Redundancy index average loading2[canonical correlation]2
A redundancy index close to one (1) is considered to be the highest. A value close to one
shows that the amount of say, the dependent variables variance being shared with the
independent variable, is significant and vice versa. Those close to zero (0) are considered
to be very low and have no significance in the variance being shared.
3.2.3 Interpreting the canonical variates. These interpretations involve examining
the canonical functions. This determines the significance of each of the original
variables in deriving the canonical relationships. The three methods for interpretation
include canonical weights (standardized coefficients), canonical loadings (structure
correlations) and canonical cross-loadings. The three procedures consider a coefficient
close to 1 (100 per cent) as being very significant. The one close to zero is very
insignificant. The research study uses all the three methods in the interpretation. From
the three procedures, canonical cross-loadings is the best.
4. Data analysis and interpretation
The statistical analysis software (SAS) was used for data analysis. The software was
used to carry out the CCA (multiple multiple regression) on stock returns and the
macroeconomic variables. The PROC CANCORR command in SAS was used to invoke
the CCA, and a SAS output was produced as shown in the Appendix.

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4.1 Deriving the canonical functions

The first statistical significance test is for the canonical correlations of each of the seven
canonical correlations functions. The seven canonical functions are:

186

Maximize 1 Max Corr (V1, W1) Maximize 7 Max Corr (V7, W7)
Subject to
Var (V1) 1 Var (V7) 1
Var (W1) 1 Var (W7) 1

(3.7)

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where Wn is a function of the macroeconomic variables, with n 1, 2, 0.7.

Vn is a function of stock returns-counters with n 1, 2 [] 8.
The fundamental question is: are all the seven canonical functions of any
practical significance? The seven canonical functions have canonical correlation
coefficients of: 0.990, 0.907, 0.760, 0.549, 0.252, 0.134 and 0.061 (SAS output first
table). The first four canonical functions are statistically significant as depicted by
the high canonical correlations which are closer to one (1). The last three are
insignificant because their coefficients are nearer to zero (0). Using the F-values for
multivariate tests, we fail to reject the first four canonical functions because they
have significant F-values either at the 1 or 5 per cent level of significance (SAS
output-multivariate statistics and F-approximations). But a use of the R2-value leads
to the rejection of the fourth canonical function, and the first three remain (SAS
output first Table fourth column). Thus, the last four canonical functions are
rejected in this first test of significance because their R2 values of 0.302, 0.063, 0.018
and 0.004 are too small. Further tests are carried out using the Wilks Lambda,
Pillais trace, Hotelling Lawleys trace and Roys greatest root (SAS output:
multivariate statistics and F-approximations). All except the Wilks lambda agree
on the overall significance of all canonical functions taken collectively.
4.2 Redundancy analysis
Table I shows the redundancy indices for the independent variables for the first canonical
function. The following information was deduced: CR2 4.1199, Average
CR 2 / 7 0.5885, Canonical R2-value 0.980576 [from output third table]:
Redundancy index Average of CR2][Canonical R2 value]
[0.58850.9805 0.5771
From the computations, we can deduce that: although an index of 0.58 is not very close to 1,
it is fairly a large index value. The index value shows some relatively high degree of
significance. Thus, we can conclude that the amount of the independent variables variance
being accounted for or shared with the dependent variable is fairly significant. From

Table I.
The independent
variables redundancy
index calculations

Loadings
Canonical loadings
[Canonical loading]2

ER

M1

CPI

M3

TB

II

0.9265
0.8584

0.7156
0.51208

0.3662
0.1341

0.9931
0.9862

0.8549
0.7308

0.0100
0.001

0.5446
0.2965

Table II, the following can also be deduced: CR2 5.2926, Average 5.2926/7 0.6616
canonical R2 0.980576.
Redundancy Index 0.66160.9806 0.6487

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From the calculations, it can be deduced that a redundancy index of 0.65 is high. This
implies that the amount of dependent variables variance being shared between the
independent variables is very significant. This redundancy analysis leads to the
conclusion that the first canonical function:
Max 1 Max Corr V1, W1
Subject to
Var (V1) 1
Var (W1) 1

Canonical
correlation
analysis
187

(3.8)

is significant in explaining the relationship between the dependent and independent

variables.
Similar computations were carried out. For the second canonical function, the
redundancy index for the independent variable was 0.031, which is quite insignificant.
The redundancy index for the dependent variable was 0.103, which again is quite an
insignificant index. Even the computations for the other canonical functions yielded
insignificant indices. Thus, all the other six canonical functions were rejected, and
ultimately, the first canonical function was chosen as the most representative of all.
4.3 Interpreting the canonical variates
4.3.1 Standardized canonical weights. [SAS output: standardised canonical weights for
the VAR variables]
Based on the size of the weights, the order of magnitude in terms of contribution of
the independent variables to the first variate is: M3 (1.96), CPI (0.832), ER (0.164), TB
(0.065), U (0.045), MI (0.026) and II (0.003). For the dependent variables they are in the
order:
Hwange (0.362), Ariston (0.117), Caps (0.216), Border (0.157), Cafca (0.156),
Barclays (0.099), Falcon (0.065) and Bindura (0.017), i.e.
W1 [M3, CPI, ER, TB, U, MI, II] for the independent variate.
V1 [Hwange, Ariston, Caps, Border, Cafca, Barclays, Falcon, Bindura] dependent
variate.
For the second canonical function:
W2 [CPI, M3, ER, U, TB, M1, II].
V2 [Ariston, Border, Hwange, Caps, Barclays, Bindura, Falcon, Cafca].

Loadings
CL
CL2

Hwang

Falcon

Caps

Cafca

Barclays

Border

Bindura

Ariston

0.9784
0.9573

0.9265
0.8584

0.7156
0.5121

0.3662
0.1341

0.9474
0.8976

0.8520
0.7259

0.6131
0.3759

0.9118
0.8314

Notes: Where CL canonical loadings; CL2 [canonical loadings]2

Table II.
The dependent variable
redundancy index
calculations

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188

W1 and W2 have some similarities in the order in which the factors contribute to the
formation of the variate and, consequently, the canonical function (model). It means that
the first five independent variables, namely, CPI, M3, ER, U and M1 are significant in the
formation of the first canonical variate and the first canonical model. The dependent set
of variables, namely, Ariston, Border, Hwange, Caps and Barclays are the top movers in
terms of contribution to the variate and the canonical model. Canonical loadings and
cross-loadings are the most appropriate methods in interpreting because they are very
robust in instances of multi-collinearity.
4.3.2 Canonical loadings. [SAS output: correlations between the with variables and
their canonical variables].
The loadings for the independent variables are: money supply (99 per cent),
consumer price index (98 per cent), exchange rate (94 per cent), treasury bills (85 per
cent), unemployment (55 per cent), mining index (51 per cent) and industrial index (1 per
cent). These figures suggest that the first four macroeconomic variables greatly
influence the formation of the first variate W1, resulting in the first canonical correlation
model. Only the contributions of the mining and industrial indices contributions fall
below the average mark of 54.5 per cent (average cross loadings for the seven
macroeconomic variables). This implies that the two indices are insignificant. The
loadings for the dependent variables are: Hwange (98 per cent), Barclays (95 per cent),
Falcon (93 per cent), Ariston (91 per cent), Border (85 per cent), Caps (72 per cent),
Bindura (62 per cent) and Cafca (37 per cent). The most influential ones include: Hwange,
Barclays, Falcon, Ariston and Border because their loadings exceed the 79 per cent
average point. Analysis of other variates is no longer necessary because an overall
pattern has been deduced already.
4.3.3 Canonical cross-loadings. [SAS output: last two tables]. Again similar patterns
appear in the cross-loading values for M3 (98 per cent), CPI (97 per cent), ER (93 per cent) and
TB (85 per cent). These figures support conclusions that were drawn earlier. If the
corresponding correlation values are squared, the percentage of the variance being
explained by the canonical variates is obtained. The values are: M3 (97 per cent), CPI (94 per
cent), ER (87 per cent), TB (72 per cent), U (29 per cent), MI (26 per cent) and II (0 per cent).
Hwange (97 per cent), Barclays (94 per cent), Falcon (92 per cent), Ariston (90 per cent),
Border (84 per cent), Caps (71 per cent), Bindura (61 per cent) and Cafca (36 per cent). The
squared values render Bindura and Cafca insignificant.
4.3.4 Overall model fitting. From the analysis above, W1 (money supply, consumer
price index, exchange rate and treasury bills) contribute significantly in maximizing
stock returns at ZSE. Thus, they should be incorporated into the final CCA model. When
developing the model, emphasis should be on the macroeconomic variables impact on
stock returns rather than the reverse. Thus, for the dependent variables, we include top
movers like V1 (Hwange, Barclays, Border, Caps, Ariston, Bindura and Falcon).
The specific model with regards to the research findings is given by:
Maximize 1 Maximize Corr (V1, W1)
Subject to
Var (V1) 1
Var (W1) 1

(3.9)

where V1 stock returns for Hwange, Barclays, Border, Caps, Ariston, Bindura, Falcon.

W1 [money supply, consumer price index, exchange rate, treasury bills].The

general canonical correlation model is of the form:

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Maximize n Max Corr (Vn, Wn)

Subject to
Var (Vn) 1
Var (Wn) 1

Canonical
correlation
analysis

(4.0)

4.4.5 Model validation and diagnosis. The last stage involves validating the prescribed
model through sensitivity analysis. The canonical loadings are examined for stability of
the model fitted. Individual values for the independent variables are deleted from the
analysis. The results obtained after omitting one value from each of money supply,
unemployment and exchange rate show little or no significant changes of the weights,
loadings and cross-loadings. This implies that the fitted model is very significant even
if the population is changed.
5. Conclusion
From the research results, the following were found: CCA identifies dimensions among
stock returns and macroeconomic variables that maximize the relationship between the
dimensions. Through CCA, the research managed to find the strength of the relationship
between macroeconomic variables and stock returns for the Zimbabwe economy during
harsh economic conditions. A fairly good model was fitted because a redundancy
index of 0.68 is very high (for a comparable multiple regression). This means that the
variance of stock returns that is being accounted for by the macroeconomic variables is
also high.
Five major macroeconomic variables, namely, money supply, treasury bills,
exchange rate, consumer price index and unemployment were found to be significant in
maximizing stock returns at ZSE. Mining index and industrial production were rejected.
Thus, a general CCA model was found that can be used by ZSE upon further scrutiny.
The model constructed can be used for prediction purposes. Thus, the model can be used
by traders at ZSE, economic regulators and the government to manage portfolios. The
model gives insight into what macroeconomic factors to closely monitor for portfolios at
ZSE to yield maximum stock returns during an economic meltdown like what the
country experienced between 1990 and 2008.
6. Practical implications and future research guide lines
Investors and stock market regulators can use the canonical correlation model to
monitor macroeconomic trends because they affect stock price movements. New
investors can have an insight of areas of investment. They can monitor the performance
of some companies in similar types of business. The research results can assist the
government in crafting economic policies for the country based on the listed stocks
reaction to movements of the macroeconomic variables. The CCA results enable
policymakers to simultaneously predict multiple stock returns from multiple
macroeconomic variables.
This research is limited to top trading counters and selected macroeconomic
variables during the research period at ZSE. Future researchers may include all the
listed companies as well as more macroeconomic variables into the model so that a

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190

broader view of ZSE is envisaged. There may be a need to incorporate other modelling
techniques such as the principal components analysis and factor analysis to
complement the CCA. For example, factor analysis can be considered with the intention
of discussing scale development. The CCA is a form of scale development. The
dependent and independent variates represent dimensions of the variable sets similar to
the relationship between them. But factor analysis maximizes the explanation (shared
variate) of the variable set. The results of the CCA model show a set of stock returns and
a set of macroeconomic variables being correlated. These two sets of variables can be
used to develop a multidimensional regression model for the ZSE. This is a matrix of all
regression models for each company and provides another dimension of analyzing the
stock market using multiple models.
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Further reading
Chen, N.C. and Ross, S.A., Economic forces and the stock market, Journal of Business, Vol. 46,
pp. 529-554.

Canonical
correlation
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Table AI.

Appendix
Tables on canonical correlation analysis and SAS output

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correlation
analysis
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Table AII.

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Table AIII.

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Canonical
correlation
analysis
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Table AIV.

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Table AV.

Corresponding author
Peter Mazuruse can be contacted at: pgmazuruse@gmail.com

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