Our explanation over how these terms are related to each other during building blocks of Theory Construction will be based on Modern portfolio Theory. The Thoery suggests that StockPrices is affected by multiple factors while the hypothesis in this study will be if there is a negative relationship between inflation and stock prices, a positive relationship between foreign exchange rate and stock prices and again a positive relationship between Real GDP and Stock Prices. In other words, the main core thrust of the hypothesis is to study the effect of Macro Economic Variables on Stock Prices.
However, many people confuse the terms Theory and Hypothesis and some related terminology of concepts, variables and sentences related to it. Theory is something that is already proved in real world after a number of observations and tested hypothesis results. While hypothesis is testable prediction as what will happen in our observation while developing our theory. For Example, in the above example of Modern Portfolio Theory we are known that stock price is affected by multiple factors- this is a theory, however, whether Inflation, Exchange Rate and Real GDP will affect our stock return is hypothesis.
Thus while building our theory, initially we have to frame out a concept relating to our study: Stock Price is affected my macro factors. However, whether stock price is affected by said variables is hypothesis. Thus, in order to explain the concept and to carry out our hypothessis, we need a set of variables to test their effect on stock price. Variables our some operational pieces that contribute in explaining the conceptual framework.
- Dependent Variable- This is the major interest of our study which is assumed to be affected by other independent- ‘The Stock Price’
- Independent Variables- These can be sole or multiple factors that affect the outcome/dependent variable- ‘’Inflation, Exchange Rate and Real GDP’’
- Modifying Variables- This variable does not affect the dependent variable but may modify it.
Now we are ready to produce a statement to lead to our real hypothesis. The statement would be like if the Dependent variable will be affected by Independent Variable i.e if Stock Prices will be affected by Inflation, GDP and Exchange Rate and an equation will be created to lead to hypothesis:
And now finally, a test will be conducted whether these three independent variables indeed had any affect on Stock Prices. Thus, though the Modern Portfolio Theory is well established that Stock Price is affected by multiple variables but whether CPI, GDP and ER are those variables is hypothesis testing.
Jecheche, P. (2008). Hypothesis Testing. In C. Institute, Quantitative Methods (pp. 34-61). Boston: Custom.