THE MACROECONOMIC VARIABLES AND STOCK RETURNS IN PAKISTAN

Abstract

The stock market is a barometer of a country’s economy. The stock market of Pakistan was initiated in the year 1947 at Karachi. Later on two more stock exchanges were established in Lahore and Islamabad in the year 1970 and 1992 respectively. The intent of this study was to explore long run and short run relationships between four stock indices i.e. KSE100 index, General index, LSE25 index, and ISE10 index relating three stock exchanges namely Karachi stock exchange, Lahore stock exchange, and Islamabad stock exchange in Pakistan and five macroeconomic variables i.e. consumer price index, industrial production index, real effective exchange rate, money supply, and three months treasury bills rate. In order to investigate the long run and short run relationships Johansen cointegation technique and VECM was applied. The study used monthly data from November 1991 to June 2008 for analyzing KSE100 index and General index, while from December 2002 to June 2008 and from July 2004 to June 2008 for LSE25 index and ISE10 index respectively. The results showed that industrial production has long run positive impact on stock returns in all three markets. Exchange rate was positively affecting all indices except ISE10.Inflation was positively related with stock returns at Karachi Stock market, while it was negatively related with rest of the two markets. Increase in money supply had negative impact on the stock returns, while treasurery bills rate had mixed effect. The VECM analysis depicted that it takes more than four months for the adjustment of disequilibrium of the previous period in case of KSE100 index. In case of General index, nine months were required for disequilibrium adjustment. The disequilibrium in LSE25 index required five months for adjustment, while ISE10 showed the most speedy adjustment i.e. two months. The results of Innovation accounting revealed that macro economic variables explained more variance of forecast error incase of KSE100 index and LSe25 index than General index and ISE10.