Structural Equation Modeling of Latent Variables Affecting Stock Prices: Evidence from Nepal

Abstract

This study uses the structural equation model in Nepali stock market, chooses investor sentiment, monetary and macroeconomic factors as latent variables, and selects a few observed variables which can explain the latent variables to study the influence on stock prices. Based on existing empirical research conclusion, influence path diagram is designed and gets its path coefficient and causal path diagram using maximum likelihood estimation. The statistical significance of the results indicated that the causal relationships of Nepal’s stock market as follows can be accepted; firstly, investor sentiment, macroeconomic indicators, and monetary factors have certain influence on stock prices, the investor sentiment has a positive correlation. Secondly, the investor sentiment has the major impact on stock prices; when investor sentiment is more stable and optimistic, stock prices will relatively be better. This research also provides certain reference to investors for rational investment decisions.