Economic freedom index and stock returns in Malaysia

The objective of this study is to investigate the relationship between economic freedom index and stock return in the Kuala Lumpur Stock Exchange, Malaysia for the period, 1995 to 2013. The analysis is conducted within the framework of Capital Asset Pricing Model (CAPM), while using the pooled ordinary least square as the method of estimation. The findings show that economic freedom index does not have significant impact on stock returns in the long run. However, overall economic freedom index has significant impact on stock returns in the short run. We further consider the impact of five components of economic freedom index. It is observed that the components do not have significant long run impact on stock returns. The components-limited government and open markets- have strong short run significant explaining powers. The results are consistent across different levels of inflation and wealth in Malaysia. The results indicate that investors can obtain better mean-variance efficiency when a country exhibit greater economic freedom. This paper should be of interest to both investors and market researchers.