Page 149 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes 7.2.5 Money and Stock Prices

Analysts have recognized that money supply in the economy plays a crucial part in the investment
decision per se. The rate of change in the money supply in the economy affects the GNP, corporate
profits, interest rates and prices. Accordingly, monetarists argue that total money supply in the
economy and its rate of change has an important influence the stock prices as a hedge against
inflation, and increases in stock prices sometimes.

7.2.6 Diffusion Index

A diffusion index is an indicator of the extensiveness or spread of an expansion or contraction.
It has been developed by the National Bureau of Economic Research, USA.

There are two main categories of diffusion index:
1. Composite or Consensus Index: It combines several indicators into one single measure, in
order to measure the strength or weakness in the movements of these particular time
series of data.
For instance, there are ten leading indicators; out of them four are moving up and others
are not. How do we interpret it?
No of members in the set in the same direction
Diffusion Index =
Total no. of members in the set
In the example, diffusion index = 4/10 = 0.4

Next month, if the index moved to 0.6, it certainly is a strong confirmation of economic
advance.
2. Component Evaluation Index: This is a narrow type of index, one that examines a particular
series taking into consideration its components. It measures the breadth of the movement
within a particular series.

7.2.7 Geometric Model Building Approach

This is an approach to determine the precise relationship between the dependent and the
independent variables. In fact, econometrics is a discipline wherein application of mathematics
and statistical techniques is a part of economic theory. It presupposes the precise and clear
relationship between the dependent and independent variables and the onus of such
well-defined relationship with its attendant assumptions rests with the analyst. Thus, by
geometrics, the analyst is able to forecast a variable more precisely than by any other approach.
But this derived approach would be as good as the data inputs used and assumptions made.
Static Model Building or GNP Model Building or Sectoral Analysis is frequently used in particular
in the methods discussed earlier. These use national accounting framework in making short-
term forecasts. The various steps while using this approach are:
Hypothesize the total demand in the economy as measured by its total income (GNP)
based on likely conditions in the country like war, peace, political instability, economic
changes, level and rate of inflation etc.

Forecast the GNP figure by estimating the levels of its various components like:
Consumption expenditure
Private cosmetic investment

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