Abstract Numerous studies have been carried out on the causal relationship between macroeconomic factors and stock variables. However, these studies have not reached common ground on the causal relationship and direction of the said variables. This study aims at addressing the causal relationship between the selected microeconomic variables (inflation, exchange rates, monetary supply and real economy) in the Hong Kong stock market. The data used covers the period between the years 1991 to 2011. Granger causality model is used to establish these relationships. The study findings reveal that inflation, interest rate and foreign sale do Granger cause stock prices. On the other hand, stock prices do Granger cause monetary supply, interest rates, exchange rates, foreign sales and purchases. Also, interest rates and foreign transaction negatively and positively determine stock prices in Hong Kong stock exchange. Lastly, the evidence tends to favour stock returns in the prediction of macroeconomic variables. Introduction Overview This chapter covers the background of the study, problem statement, research objectives and hypotheses and the significance of the study. Background to the study Investment is generally described as the commitment of financial resources on a particular venture. The biggest challenge facing most investors or portfolio managers is the determination of the value of an investment; whether it is worth its price (Abdalla & Murinde, 1997, p.25). Investors need to consider the intrinsic value of any investment using the prevailing market price before committing financial resources. Since the estimation of financial asset value is not easy, numerous methods of valuation have been developed over time (Bodnar & Wong, 2000, p.4). These valuation methods use various inputs, for instance, cash flows, rates of inflation, interest rates, rate of returns, exchange rates, risk premiums among others. These inputs greatly influence the aggregate return on investment. Also, since companies are based in different environments, they are exposed to different macroeconomic variables. Thus, both internal and external conditions a firm is subjected to must be taken into consideration during the process of investment valuation (Bodnar & Wong, 2000, p.5). Theoretically, macroeconomic factors are believed to be the main cause of stock market volatility. Thus, they are considered to be the key indicators of stock returns (Chatrath, Ramchander & Song, 1997, p.2). According to Chatrath, Ramchander and Song (1997, p.3), the volatility of market portfolio returns and the ratio of anticipated profits to anticipated aggregate revenue to the economy are inversely proportional. Nardari and Scruggs (2005, p. 1) argue that increased uncertainty concerning future return is significantly related to the economic downturn. Nonetheless, Nishat and Shaheen (2004, p. 620) state that stock prices are the principal indicators and that the change in stock prices always occurs before changes in business activities. According to a study conducted by Chatrath, Ramchander & Song (1997, p. 440), the evidence tends to favour stock returns in the prediction of macroeconomic variables. Therefore, stock prices a