Impact of Macroeconomic Variable on Stock Prices in Pakistan

8/12/2019 Impact of Macroeconomic Variable on Stock Prices in Pakistan

http://slidepdf.com/reader/full/impact-of-macroeconomic-variable-on-stock-prices-in-pakistan 1/8Electronic copy available at: http://ssrn.com/abstract=1683357

European Journal of Scientific ResearchISSN 1450-216X Vol.38 No.1 (2009), pp.96-103© EuroJournals Publishing, Inc. 2009http://www.eurojournals.com/ejsr.htm

Impact of Macroeconomics Variables on StockPrices: Emperical Evidance in Case of KSE

(Karachi Stock Exchange)

Sulaiman D. Mohammad Associate professor, Federal Urdu University of Arts, Science and Technology, Karachi

E-mail: [email protected]

Adnan Hussain M.Phil Fellow, Applied Economics Research Centre, University of Karachi


M. Anwar Jalil M.Phil Fellow, Applied Economics Research Centre, University of Karachi


Adnan Ali M.Phil, Fellow, Applied Economics Research Centre, University of Karachi


Abstract

The purpose behind this study is to explore the correlation among themacroeconomics variables and share prices of KSE (Karachi Stock Exchange) in context ofPakistan. The study consider several quarterly data for different macroeconomics variablesare as foreign exchange reserve, foreign exchange rate, industrial production index (IPI),whole sale price index (WPI), gross fixed capital formation (GFCF) and broad money M2.These variables are obtained from the period 1986-2008. The result shows that after thereforms in 1991 the influence of foreign exchange rate and foreign exchange reservesignificantly affect the stock prices, while other variables like IPI and GFCF areinsignificantly affect stock prices. The result also highlighted the internal factors of firmlike increase in production and capital formation insignificant while external factor like M2and foreign exchange affect positively. The study will be very helpful for national policymakers, researchers and corporate managers.

Keywords: Stock prices, Macroeconomics variables

IntroductionIn modern economy the role of stock exchange is very important. It can be very helpful to diversify thedomestic funds and channels into productive investment, however to perform this important task it isvery necessary that stock market have significant relationship with the macroeconomics variables.Nowadays capital market became a key element of modern market based economy. They transfer thelong term funds from savers to borrowers of capital which is very essential for economic development.


http://slidepdf.com/reader/full/impact-of-macroeconomic-variable-on-stock-prices-in-pakistan 2/8Electronic copy available at: http://ssrn.com/abstract=1683357

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance inCase of KSE (Karachi Stock Exchange) 97

Economic growth and prosperity is possible only when capital market works efficiently. After theglobalization international capital markets are integrated rapidly. This integration has positive affectson economic growth, reducing the risk and especially contagion impact on financial crises.

The EMH (efficient market hypothesis) suggests that all the necessary or relevant informationto investors about profit maximizing and the macroeconomics variables fall the possibility of earningsupernormal profit. Therefore the stock prices are fully reflecting the current position ofmacroeconomics variables. (Chong and Koh 2003).

The portfolio managers and investment advisors are not able to help the investors to earnsupernormal profit continually. If EMH is continually follow in stock market the role of stockbrokerage firms diminishes gradually.

Stock market plays the vital role to transfer of funds from capital borrowers to capital investorswhich is very essential for economic growth. In other words the stock market is very significant tospeed up economic growth through increasing liquidity of financial assets and diversification of globalrisk easier for investors to make a wiser investment decision. (Agrawalla 2006). A well performingstock exchange is very helpful for economic activity through growth and saving, efficient allocation ofinvestment and attracting FDI (foreign direct investment). The stock market gives confidence to saversby providing domestic house- holds having invest able funds, innovation in financial instruments,which diversify their risk and better sharing in investment projects (Agrawalla 2006).

II. History of KSE (Karachi Stock Market)Since the independence (1947) a number of problems have been stood in the way of economic growthand development in Pakistan. In which included social, economic and political problems such asincreasing population, bureaucratic problem, policy inconsistency, violence and political instability.Economic problems include unproductive tax rate, delicate custom duties which adversely affectforeign investment. Pakistan government strategic approach is also towards closed the economy.

As discussed that Pakistan has been faced socio and political problems. In 1991 economicreforms were taken to resolve these problems. The most important reforms were to liberalize the stockmarkets for foreign investors and allowing first time in the history of Pakistan foreign direct andindirect investment landing. These reforms had positive impact on stock market index.

Karachi stock exchange (KSE) is the largest and most dynamic stock exchange in Pakistan. Theshare of KSE is about 70 percent of total stock transition. On October 1, 2004, there are 663 companieswere registered or listed in KSE. The market capitalizations were $23.23 billion. Pakistan foreigninvestment and industrial export is rapidly grown. Pakistan foreign exchange reserves reached $12.327billion in 2003-04. Nowadays our all stock markets traded on international market. SECP (Security andexchange commission of Pakistan) has permitted foreign and local brokerage houses to make jointventures which give the newfound interest in the Pakistan stock markets.

In Pakistan, Karachi Stock Exchange is a leading stock exchange. It was stated the “BestPerforming Stock Market of the World for the year 2002”. The KSE 100 Index reached at 5315.82 on1st October 2004. KSE has been ranked for three years of being one of the Best Performing Markets ofthe world as ranked by “Business Week” which is an international magazine. As well as a leading USnewspaper, “USA Today” mentioned Karachi Stock Exchange as one of the best performing stockexchange in rest of the world.

Karachi stock exchange attained a major landmark when KSE-100 index had reached at thepsychological level of 15500 for the first time in the history and later on reached at 15737.32 on 20April 2008 but due to recent financial crises KSE declined to 9000 because of larger foreign capitaloutflows. Around 654 companies were listed at KSE with market capitalization of US $ 33.81 billionon September 25 2009.


http://slidepdf.com/reader/full/impact-of-macroeconomic-variable-on-stock-prices-in-pakistan 3/8

98 Sulaiman D. Mohammad, Adnan Hussain, M. Anwar Jalil and Adnan Ali

Literature ReviewDr. Nishat (2004) evaluates long term association among macroeconomic variables, stock prices andemployed money supply, CPI, IPI, and foreign exchange rate as explanatory variable. The result showsthat there are causal relationships among the stock price and macroeconomics variables. The data usedin this study from 1974 to 2004. Most of the time series data is nonstationary therefore unit roottechnique is used to make data into stationary. The result also indicates that industrial production issignificantly affects to macroeconomic variables. Nishat used Karachi stock exchange 100 index pricefrom 1974 to 2004. Grange causality test is used to find the correlation among the variables the resultof granger causality shows that interest rate is not granger cause by stock price.

Shahid Ahmed (2003) empirically investigated on SENSEX index price affects due to real andfinancial sector performance in Indian economy, the data has been chosen from the period 1997 to2007. The study consists variables export and foreign exchange rate and foreign direct investment.Granger causality test is used to find out the causal relationship between the variables. All the variablesare Granger cause to stock prices. Speculation in the market was analysis with the help of AR (AutoRegressive) which was highly significant according to the result.

Fazal Hussain and Tariq Masood (2001) used variables investment, GDP and consumptionemploying granger causality test to define the relationship among the selected variables and stockprices, finding shows at two lags of all variables are highly significantly effect on stock prices. RobertD. gay (2008) evaluated the association among stock prices and macro economics variables in cases ofChina, India, Brazil and Russia which are emerging economies of the world using Oil price, exchangerate, and moving average lags values as explanatory variables employing MA (Moving Average)method with OLS (Ordinary least square) and found insignificant results which postulate inefficiencyin market. Finally they concluded that in emerging economies the domestic factors influence more thanexternal factors i.e. exchange rate and oil prices.

Dr. Aftab (2000) examines the association between monetary and fiscal policy of Pakistan toequities market and the result of his analysis is significant. The result shows that fiscal and monetarypolicy could change market capitalization by liquidity and equity which can significantly effect themarket capitalization and stock prices in case of Pakistan from the period 1993 to 1998. Liaquat Aliand Nadeem Ahmed (2008) used data from 1971 to 2006 and try to find out the relationship ofeconomic growth with stock market prices and study shows that there are dynamics associationbetween stock prices and economic growth employing DF-GLS test first time in case of Pakistan.

M. Shahbaz (2006) investigated the association between stock prices and rate of inflation usingARDL approach for dynamics analysis. Result of this study depicts that stock hedges are not in favorof inflation in long run as well as in short run and found that black economy effects long run and shortrun prices of the stock. The study used variables CPI, (inflation) and share of black economy thesample size of the study is 1971-2006.

Safail Sharma (2007) used interest rate, exchange rate and reserve, industrial production index,monetary growth and inflation as independent variables with AR and MA to nullify the effects of nonstationary in the variables. The result shows that lags values are highly connected with current shareprices which recommend the speculation in market. Exchange rate and reserve, industrial production

index and monetary growth are significantly associated. The study took data set from 1986 to 2004. Desislava Dimintrova (2005) used multivariate model and try to find out link among stock

prices, exchange rate and economics policy (fiscal and monetary policy). The study defines the interestparity condition affects on stock prices. The result shows that ambiguous affects of deprecation onstock prices.




IV. Econometrics Methodology and Data Base4.1. Data Base

The assets valuation model and pricing of macroeconomics variables• Stock prices and foreign exchange rate and reserve: the positive relation between foreign

exchange and stock price is found. FDI is increased if there is liberalization of stock market

prevailed in any economy which may cause to increase FDI and raise stock prices. psr =+Ψ+∑= δ λ /

Where =λ is total gain which equal to price of shareπ = net dividend / profitψ = capital gainr = real interest rate

=δ Risk premiumps = price of shares

• As stock market is liberalized it can cause to reduce the risk premium and increase competitionsin stock market ultimately stock prices have been increased. As foreign exchange currencyinflows resulting increases in supply which can cause to appreciate local currency consequentlyprices of share increase and that improve foreign exchange reserves which cause to appreciateexchange rate while other factors remain constant.

• Stock prices and interest rate: increase in interest rate cause to increase opportunity cost ofholding money which can cause to change portfolio diversification between stock and interestbearing securities as a result stock prices fall. Another reason for falling stock prices is that wheninterest rate increases it can cause to raise cost of production which deteriorate companies profitand dividend results reduce the prices of shares.

• Stock market and money supply: increase in money supply cause to increase in inflation thereforepeople maintained there real cash balances consequently they sell shares and other assets whichcause to decline the share prices but on the other hand increase in monetary growth reduces the

interest rate which cause to reduce cost of capital and increase earning of corporation.• Industrial production index and stock prices: the IPI and stock prices are positively relatedbecause increase in IPI cause to increase in production of industrial sector which cause toincrease the profit of industries and corporations. As dividends increase resulting share pricesraise therefore it is found positive association between IPI and share price according to economictheory.

• Gross fixed capital formation and share price: gross fixed capital formation is defined as fixedassets accumulation. Assets accumulation are increased by bonds financing and equity financing,if corporations want to finance assets they float their shares in stock market as a result supply ofshares increase which cause to decline share prices. On the other hand when assets financing isincreased by purchasing of bonds consequently firms/corporations credit become worthiness.

Economic theory suggests that increase in Gross fixed capital formation cause to decline shareprices in short run but in long run production is increased which cause to raise share prices.ε β β β β β β β β ++++++++= LWPI LM LIR LIIP LGFCF LRER LEXERS LSP 87654321 2 (1)

All the variables are taken in a form of monthly data. The data is taken from IFS (InternationalFinancial Statistics) from various issues and Economic Survey of Pakistan. The sample size of data istaken from the period 1987-2007. The logic behind of it that the sample period 1987-2008 and 1991the era of reforms of financial sector and liberalization of stock markets in Pakistan.




4.2. Econometrics Methodology

The study consists time series data for econometrics analysis so several preliminary statistical stepsmust be taken. The steps included descriptive statistics, unit root, and Auto Regressive IntegratedMoving Average (ARIMA) model testing. The nature of time series data found non stationary in manycases therefore it is necessary to check stationary of the data. Stationary is defined as mean andvariance of the data is zero and constant respectively. The ADF (Augmented Dicky Fuller) test is usedto analyze the stationary of variables. The model of ADF is used as follow

∑ ++++=−− η ρ β α 1t jt r at r r (2)

Here null hypothesis is non stationary and alternative hypothesis is stationary. To checkstationary of all the macroeconomic variables by ARIMA to change them into stationary.

V. Result AnalysisThe empirical result or evidence provided by the various studies mentioned in the section of reviewliterature shows that macroeconomics variables have strong effect the stock market. On the other handKarachi stock market is declared to be inefficient collaborator with respect to the mostmacroeconomics variables. If market is ineffective with respect to information then it has essential toanalysis the statistical inconsistency of the variables. As shown in table no. 1

Table 1: Statistical Discrepancy

SP EXCRES EXR GFCF IIP IR M2 WPIMean 127.6368 3553.989 39.89068 110574.6 105.5122 8.030114 400084.3 81.3842Median 103.56 1322 39.765 89578.5 92.29 7.89 395424 84.305maximum 299.21 14435 64.15 396551 232 15.42 1043700 164.25minimum 34.57 213 15.98 17259 52.52 1.05 69875.9 27.94Std. Dev. 78.14981 4217.17 16.81541 88349.3 43.29091 3.050957 280527.7 38.89997Skewness 0.972571 1.163066 0.019702 1.241375 1.104169 0.175299 0.411707 0.274529Kurtosis 2.73852 2.669788 1.386929 4.173968 3.264533 2.924647 2.089966 1.960819

Jarque-Bera 14.12381 20.23975 9.546355 27.65491 18.13803 0.471524 5.522628 5.064995probablity 0.000857 0.00004 0.008453 0.000001 0.000115 0.789969 0.063209 0.07946observation 88 88 88 88 88 88 88 88

As mentioned in above table no.1 that all the variables are positively skewed which show thatthey are asymmetrical. Kurtosis values of all variables also show that the data is not normallydistributed because values of kurtosis are deviated from 3. So the descriptive statistics shows that thevalues are not normally distributed about its mean and variance. It is said that no randomness in thedata therefore, being sensitive to speculation shows periodical changes. This indicated that individualinvestors can earn considerably higher rate of profit from the Karachi Stock Market. Hence the resultsof descriptive statistics raise the issue the inefficiency of market. The funds and investment in marketare not allocated to the productive sector of the economy.

The result of unit roots test suggested that data/variables are not stationary at level except grossfixed capital formation other wise all variables are non stationary at level but they are stationary at firstdifference level. The value is 5% level significant of first difference level. ADF method is used to findout stationary of data as suggested in section 5 of this paper.




Table 2: Unit root test / Augmented Dicky Fuller test

Variables At level At first differenceShare price -1.426297 -3.923520*Gross fixed capital formation 3.311289 -5.618675*Foreign exchange reserve -1.335140 -4.189409*Interest rate -1.647429 -9.058792*Industrial index of production 1.797305 -13.81579*Whole sale price index (wpi) -1.621632 -4.723153*M2 (Broad Money) -0.978078 -6.420688*Foreign Exchange rate -0.250161 -4.120358*

Table 3: Dependent Variable: SP

Variable Coefficient Std. Error t-Statistic Prob.C 462.2149 729.6082 0.633511 0.5281AR(2) 0.983048* 0.035285 27.85994 0.0000MA(1) 0.983110* 0.012342 79.65724 0.0000Significance level at 5%

As evident from table-3 Karachi stock share prices are autoregressive of order 2 and highlysignificant, moving average is also very highly significance shows that prices are highly seasonal. Thusstudying the impact of macroeconomics variables lagged prices of Karachi stock exchange are alsotaken as independent variables.

Table 4: Dependent Variable: SP

Variable Coefficient Std. Error t-Statistic Prob.C 50.93326 47.72902 1.067134 0.2893EXCRES 0.004599** 0.002749 1.673216 0.0984

EXR -2.645900* 1.125605 -2.156000 0.0356GFCF -0.000134 9.09E-05 -1.471965 0.1452IIP 0.151023** 0.086775 1.740394 0.0858IR -1.242176* 0.595195 -2.087007 0.0402M2 -3.59E-05* 1.86E-05 -1.931914 0.0571WPI 2.411239* 0.813718 2.963239 0.0041AR(2) 0.820881* 0.075523 10.86930 0.0000MA(1) 0.989783* 0.001822 543.0924 0.0000*Significance level at 5% **significance level at 10%

Further analysis also reported in table-4 exhibits foreign exchange rate is highly significance at4% level. It is found that negative relationship with KSE which shows that foreign institutions’investment has been significant factor affecting the stock market prices, as foreign investmentincreases results foreign exchange reserves also increases thus exchange reserve is positively relatedwith stock price at 10% significance level. IPI is also significance at 9% level which suggested that asindustrial production increases consequently stock prices increase. Interest rate is negatively relatedwith stock prices as interest rate increases as a result stock prices fall down which is defined in section4.1. Interest rate is significantly effect at 4% level. M2 is negatively related with stock prices andsignificant at 6% level.




VI. ConclusionThe result of this study pointed out that changes in macroeconomics variables are not trading rule byinvestors to gain continually supernormal profits in the stock exchange market. The result of AR(Autoregressive) and MA (Moving Average) suggest that current as well as past knowledge about thedevelopment of variables are also incorporate with share prices. Thus, the investors are not able togenerate supernormal profit using the available information.

The main objective of this research paper is to study the association between macroeconomicsvariables and Karachi stock market’s shares prices. For this purpose the quarterly data of foreignexchange rate, foreign exchange reserve, gross fixed capital formation, M2, Call Money Rate (interestrate proxy), Industrial production index and whole sales price index (proxy of inflation) have beenchosen. The result shows that exchange rate and exchange reserve highly affect the stock prices. It hasbeen observed since the liberalization in 1991 of stock markets in Pakistan has largely increased stockprices in Pakistan. The empirical result also suggests that IR and M2 is also significant and negativelyeffect to stock prices. However, few variables like IPI and GFCF neglect able effect to stock pricesthus result suggested that increase in capital formation by firms and increase in industrial productiondo not affect stock prices.

Reference[1] Shefali sharma and balwinder Singh (2007) share prices and macroeconomics variables in

India, retrieved on Artja vijnana June 2007[2] Dr. Nishat (2004) Macro economics factors and Pakistan equity market retrieved by May 2004[3] Hasan fazal and Mehmood tariq (2001) the stock market and economy of Pakistan retrieved in

PIDE (Pakistan institute of development economics)[4] Stock Prices, Real Sector and the Causal Analysis: The Case of Pakistan (2004) retrieved by

journal of management and social sciences[5] Dr. Ayub mehar Stock market consequences of macroeconomic fundamentals (2001) retrieved

in MRPA[6] Dr. Shahbaz Akmal (2007) Stock return and inflation in case of Pakistan retrieved in Pakistan

social and development review[7] Robert D. Gay, Jr (2008) Effect Of Macroeconomic Variables On Stock Market Returns For

Four Emerging Economies: Brazil, Russia, India, And China retrieved in international financeand economic journal

[8] Desislava dimitova (2005) The Relationship between Exchange Rates and Stock Prices:Studied in a Multivariate Model retrieved in issue in political economy

[9] Song zan chiou wei (1997) macroeconomics determinates of stock return and volatilityretrieved in managerial economics journal

[10] Chen, N. F., Roll, R. & Ross, S. 1986. Economic forces and the stock market. JournalofBusiness 59(3): 83-403.

[11] Cooper, R. 1974. Efcient capital markets and the quantity theory of money. Journal of Finance29(3): 887-908.

[12] Fama, E. F. 1981. Stock returns, real Activity, ination and money. The American EconomicReview 71(4): 45-565.

[13] Jorgenson, D.W. 1967. “The theory of investment behaviour”. In R. Ferber, ed.,[14] Determinants of Investment Behaviour. New York: National Bureau of Economic Research[15] Shapiro, M.O. 1986. :Investment, output and the cost of capital”. Brookings Papers on

Economic Activity, 1: 11 l-52.[16] Economic survey of Pakistan 2007-08[17] B., Chatrath, A., & Sanvicente, A. Z. (2002). Inflation, output, and stock prices: Evidence from

Brazil. Journal of Applied Business Research, 18, 1, 61-76.




[18] Abdullah D. A. & Hayworth, S. C. (1983). Macroeconometrics of stock price fluctuations.Quarterly Journal of Business and Economics, 32, 1, 49-63.

[19] Diacogiannis, G. P., Tsiritakis, E. D., & Manolas, G. A. (2001). Macroeconomic factors andstock returns in a changing economic framework: The case of the Athens stock exchange.Managerial Finance, 27, 6, pg 23-41

[20] Sharma, J.L. and R.E. Kennedy, 1977, A Comparative Analysis of Stock Price Behavior on theBombay, London, and New York Stock Exchanges, Journal of Financial and QuantitativeAnalysis 17, 391-413.

[21] Lee, B.S, 1992, Causal Relationships Among Stock Returns, Interest Rates, Real Activity, andInflation, Journal of Finance, 47, 1591-1603.

[22] Nishat. M., and M. Saghir, 1991, The stock Market and Pakistan Economy. Savings andDevelopment 15:2. 131- 145

[23] Dwyer, G.P. and M.S. Wallace, 1992, Cointegration and Market Efficiency, Journal ofInternational Money & Finance, 14, 801-821.

[24] Annual reports of state bank of Pakistan (2007-08)[25] National Accounts of Pakistan (product and Expenditure), Federal Bureau of Statistics,

Statistics Division, 1988-89, 1998-1999 and 2008-09 Islamabad.

Impact of Macroeconomic Variable on Stock Prices in Pakistan

Documents

Transcript of Impact of Macroeconomic Variable on Stock Prices in Pakistan