Long Run Relationship Between Macroeconomic Performance of Pakistan and Its Stock Market: A Dynamic Econometric Analysis

Abstract

The present study investigates relationship between the stock market and macroeconomic indicators of Pakistan by using monthly data from 1992M01 to 2012M12. In this empirical study, certain econometric techniques have been used to estimate linear regression models with OLS, ARDL cointegration, vector error correction mechanism (VECM). Furthermore, causality between performance of Pakistan stock market and its macroeconomic performance have been investigated by employing Pairwise Granger-causality tests devised by Granger (1988); Engle and Granger (1987) and Granger et al. (2000). On existence of bi-directional causality between performance of Pakistan stock market and its macroeconomic performance a system of simultaneous equations have also been estimated by the method of Two-stages least squares.

Statistical results generated from the above estimated models indicate that macroeconomic variables such as Taxes on Products (TAX), Consumer Price Index (CPI), Money Supply (M2), Nominal Exchange rate Pakistan Rupees per US Dollar (EXR), Gross Domestic Savings (SAV), Gross Domestic Product (GDP) and Nominal Interest Rate (INT) at levels and with lagged values have impact on the performance of Pakistan stock market proxied by KSEI, KSER, KSECAP, KSETV and KSETO. Results also show that TAX has insignificant impact on Pakistan stock market when the performance of stock market is proxied by KSEI, KSER, KSECAP, and KSETV. Contrast to it, TAX has positive and significant influence on the performance of Pakistan stock market when it is proxied by KSETO but negative impact in the following month.

Results also indicate that inflation proxied by consumer price index (CPI) has negative impact on levels and positive impact in the following month and, then negative after two months on the performance of the stock market of Pakistan when proxied by KSEI, KSER, KSECAP and KSETV.

The statistical results also indicate that money supply in the broader sense proxied by M2 has negative impact on levels and positive impact in the following month and, then negative after two months on the performance of the stock market of Pakistan when proxied by KSEI, KSER, KSECAP and KSETV.

The statistical results obtained from the estimated techniques used in the study also indicate that nominal exchange rate has negative effect on levels and positive impact in the following month and then negative after two months on the performance of the stock market of Pakistan when proxied by KSECAP and KSETV but this impact reverses for KSETO. Meanwhile, it is also found from x the statistical results that saving has significant positive effects on levels and negative impact in the following month and, then positive after two months on the performance of the stock market of Pakistan when proxied by KSECAP.

Results also indicate that savings have inverse but significant impact on levels, positive after one month and, then negative in the following month when the performance of the stock market of Pakistan is proxied by KSETV. On the other hand, it is found from the results that economic growth of Pakistan (GDP) has negative and significant effect on levels, positive in the next month and then positive after two months on the performance of the stock market of Pakistan when proxied by KSECAP and KSETV.

The empirical results regarding the interest rate indicates that interest rate has positive and significant effect on level and negative impact in the following month on the performance of the stock market of Pakistan when proxied by KSECAP and KSETV. Meanwhile, results also conclude that interest rate has negative and significant impact in the current month and inverse in the following month on the performance of the stock market of Pakistan when proxied by KSETO.

Statistical results also show that long run equilibrium relationship does exist between macroeconomic variables including TAX, CPI, M2, EXR, SAV, GDP and INT and the stock market of Pakistan proxied by KSEI, KSER, KSECAP and KSETO.

Further, vector error correction mechanism (VECM) from ARDL (p, q) represents that long run equilibrium relationship does exist between macroeconomic variables and the stock market of Pakistan proxied by KSEI, KSER, KSECAP and KSETO. Also, error correction term indicates that long run equilibrium relationship between macroeconomic variables and the stock market of Pakistan does exist when performance of stock market is proxied by KSEI, KSER, KSECAP and KSETO. Meanwhile, estimated error correction term also represents the speed of adjustment in case of any departure from the long run equilibrium and it is estimated as 126.5237 percent or in other words it takes 24 days to fade away any departure from long run equilibrium in case of macroeconomic variables and performance of the stock market of Pakistan proxied by KSEI. Similarly, the speed of adjustment is 18.26 percent and it takes 164.29 days, 1.2830 percent and it takes 2343.82 days, 3.8285 percent or it takes 785.34 days to adjust back to long run equilibrium in case of any departure between macroeconomic variables and KSER, KSECAP and KSETO, respectively. Statistical results lead to conclusion that bi-directional granger causality does exist between economic growth and stock market of Pakistan proxied by KSECAP.

The current empirical research also investigates the impact of macroeconomic variables on the stock market of Pakistan based on simultaneous equations system on existence of bi-directional granger causality. Moreover, simultaneous equations system is estimated by using 2SLS estimation technique and results lead to the conclusion that economic growth had significant impact on the stock market of Pakistan and simultaneously the stock market of Pakistan has significant impact on economic growth of Pakistan.

The current empirical study has short run as well as long run implications especially when policy makers are designing policies about the growth prospects of financial markets, fund manager making investment decisions to invest in the capital markets, and project managers formulating capital investment decisions in emerging economies like Pakistan. Further, implications are useful for retail investors looking for good returns on investments in capital markets such as stock market. Hence, by considering the role of macroeconomic variables in performance of stock market a better policy can be formulated to enhance the growth of capital markets included stock market that in turn will increase the economic growth of emerging economies like Pakistan.