The existence of an efficient equity market, an integral part of financial system, is a pre-requisite for the smooth functioning of an economy.

The equity markets cater the needs of finances for the private investments and public sector development programs and play an important role in mobilizing institutional and individual saving and channeling these to the productive activities of the economy. An efficient equity market therefore helps in expanding the commercial and industrial base, thereby stimulates economic activity, the end of which is increase in job opportunities and per capita income. Stock markets are referred to as foundations to the national economy. The reason is that, for strong economic growth and development; the existence of a vibrant equity market is the basic pre-requisite. In essence stock markets serve the purpose of supporting and complementing the productive activities of the economy by performing functions regarding the mobilization and allocation of savings for the long term funding exigencies of business and industry. Thus stock markets help in Javed Mehboob (MBA) Final Research Report 3 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). expanding the commercial and industrial base and a result creating job opportunities and increasing national output and per capita income. Stock exchanges also provide necessary stimulant to institutions working for promoting virtue of thrift, in carrying out their aims and objectives that are mainly to attract savings and to utilize them profitably for industrial development. With these actions of the capital market the base of industrial finance has greatly widened and a large number of small investors are induced to put their savings in equity investment. Thus it is obvious that for such a purpose the existence of the stock markets become indispensable. At the time of independence, there were only a few industries in Pakistan and the related institutional framework was weak. A few insurance companies and the managing agency systems were the only platform for trade in funds. Commercial banks were mostly engaged themselves in financing commercial operations. The establishment of State bank of Pakistan in 1948 as the central bank of the country laid foundation for an organized money market. The need to establish a stock exchange was felt at the time of independence and the government had taken steps to setup a stock exchange at Karachi in September 18, 1947, which was converted into a registered company limited by guarantee on March 10, 1949. At that time it had 90 members and 13 listed companies with paid up capital of Rs. 108 million. Though there were two other stock markets, later established in Pakistan at Lahore and Islamabad in 1970 and 1992 respectively. The Karachi Stock Exchange remains the main center of activity Javed Mehboob (MBA) Final Research Report 4 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). where 75-80 % of the current trading takes place. Most of the companies Lahore and Islamabad stock exchanges are also listed at Karachi stock exchange. The turn over of Karachi stock exchange is fairly contributed by these two smaller but fast growing regional stock exchanges whose members send the unexecuted orders at their exchange to the Karachi stock exchange floor. The main equity market in Pakistan is Karachi Stock Exchange (KSE), has been in operation for almost half of century. It has not been an active market until the beginning of 1991. During the year 1994, frequent crashes of the stock market show that the KSE is rapidly converting into a volatile market. Heavy fluctuations in stock prices are not an unusual phenomena however, such

fluctuations have been observed at almost all big and small exchanges of the world. The major fluctuation has been observed in year 2001-2002 is after the 11t h September event. The stock prices have been very frequently fluctuate, and the stock market also affected by the 10t h October 2002 Elections. Pakistan had nuclear test on May 28, 1998 that has significant impact on KSE 100 and it declines from 1040.19 to 789.15 and trading volume from Rs 16 million to Rs 9 Million. The recent attack of USA on Iraq have also affect the Pakistani stock markets in March 2003.The frequent fluctuations in the stock market have been occurred due to uncertainty. Focusing on the reasons for such fluctuations is intrusive, and likely to have important implications. Nevertheless, the KSE offers an interesting set of circumstances to test the nature of market volatility. Javed Mehboob (MBA) Final Research Report 5 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). Pakistan used number of measures in order to develop its capital markets, the major measures include economic liberalization, regulatory changes in foreign exchange controls, repatriation of profits and privatization of public sector enterprises and, most importantly, the opening of the equity market to international investors during 1991. However, the equity market in Pakistan is likely to regain its importance in the near future, especially in the light of major developments. Like, following the loan agreement with international monetary fund (IMF), Pakistan has been able to receive aid inflows from many sources, such as World Bank, Asian Development Bank and Islamic Development Bank and debt rescheduling arrangements are in the process. It has been observed that in the past few years the opening of the Pakistani equity market to international investors has exposed it to frequent crashes, which indicated that the KSE, LSE, and ISE are highly volatile markets. The fluctuations in stock prices are usual phenomena and are daily observed in almost all stock markets of the world, small as well as large. The average investors are risk averse, his/her objective is to maximize return with the minimum risk. Thus, given the rate of return, the stock markets that are relatively less volatile, are likely to attract more investment. However, what matters in the individuals investment decision is the perception rather than realization; past experience matters to the extent that it influences future expectations about return and volatility. In other words, while making their investment decision investors consider expected return and expected volatility Javed Mehboob (MBA) Final Research Report 6 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). conditional upon the available information. Thus the stock markets activities are usually governed by information. While the systematically disseminated information determines the ling-term trend and underlying strength of the market, the information that comes as a surprise eventthe so called good or bad news- cause shocks to the stock markets and result in volatility. The ways investors interpret this news are crucial in forming expectations about the future course of events in the stock markets. One relevant question is always remained on the forefront of financial theory, why the investors take risk of volatility when a wide range of safe assets exist. There is also a straight quotation, that high risk leads high return. A possible answer is given by the postulate that returns on stocks include a premium for risk that provides a sufficient incentive to take risk. This postulate has been known as Capital Asset Pricing Model or CAMP. Although this

postulate has been applied time and again on almost all the major stock markets in the world, it has not been tested thoroughly for the KSE. 1.1 OBJECTIVE OF THE STUDY The study is undertaken to address the following issues pertaining to activities at the KSE. Javed Mehboob (MBA) Final Research Report 7 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). To verify how risk affects the selected stock prices? To verify the relationship between risk and return of selected stocks? To verify nature of volatility in selected stocks, and how volatility affects the selected stock Returns? 1.2 PROBLEM STATEMENT Literature describes that there is strong relation between risk and return, and they have great impact on stock return, sometimes this impact is positive and sometimes it is negative. It will be verified that how the risk affects the stock prices. Risk and return both are always be with stock market and have very strong relation. This report will verify the relationship between risk and return. One relevant question is always remained on the forefront of financial theory, why the investors take risk of volatility when a wide range of safe assets exist. This report studies the nature of volatility on the stock return and to verify how the volatility affects the stock return. It is very helpful for the individual investor to know how the stock market behaves and how the risk affects the stock prices. This research report is very beneficial for the individual investor to know that how volatility affects stock return. Javed Mehboob (MBA) Final Research Report 8 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility In Pakistan (KSE). 1.3 THEORATICAL FRAMEWORK The aim of this section is to define the relationship between the dependent and the independent variables. In this particular study, the dependent variable is return while the independent variable is risk. Fama and French in (June 1992): They tested stock returns over the 19631990 period, they found that the size and market-to-book-value variables are powerful predictors of average stock returns. The risk and return have great impact on stock prices. This effect can be either an increase or decrease in stock prices. This impact may be the systematic risk factors or due to the unsystematic risk factors. The impact of risk on return is not a new phenomenon. The risk factor can be minimized but it cannot be eliminated entirely. Risk and return are interlinked, higher the risk depicts higher the return and lower the risk represents lower return. Farid and Ashraf (1995): describes that there was a strong positive correlation among the volume of trading, expected rate of return and volatility of stock prices. Uncertainty leads volatility. Uncertainty and volatility have direct relation, if the environment is highly uncertain than it leads high volatile market. Volatility is measured by the Beta. Fama and French (June 1998): describes that high beta describes that the firm is risky. The measure for this non-diversifiable risk is the beta coefficient -- which measures the volatility of an asset's returns compared to volatility of overall market returns. The higher the potential return, the higher the potential loss may be, and that negative returns are possible for all investment types. Though the literature Javed Mehboob (MBA)

Final Research Report