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An Analysis of Stock Market Behavior

An Analysis of Stock Market Behavior

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Published by fraben1
An Analysis of Stock Market Behavior
An Analysis of Stock Market Behavior

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Published by: fraben1 on Oct 31, 2013
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The existence of an efficient equity market, an integral part of financialsystem, is a pre-requisite for the smooth functioning of an economy. The equitymarkets cater the needs of finances for the private investments and public sector development programs and play an important role in mobilizing institutional andindividual saving and channeling these to the productive activities of theeconomy. An efficient equity market therefore helps in expanding thecommercial and industrial base, thereby stimulates economic activity, the end of which is increase in job opportunities and per capita income. Stock markets arereferred to as foundations to the national economy. The reason is that, for strongeconomic growth and development; the existence of a vibrant equity market isthe basic pre-requisite. In essence stock markets serve the purpose of supportingand complementing the productive activities of the economy by performingfunctions regarding the mobilization and allocation of savings for the long termfunding exigencies of business and industry. Thus stock markets help inJaved Mehboob (MBA)Final Research Report3 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE).expanding the commercial and industrial base and a result creating jobopportunities and increasing national output and per capita income.Stock exchanges also provide necessary stimulant to institutions workingfor promoting virtue of thrift, in carrying out their aims and objectives that aremainly to attract savings and to utilize them profitably for industrialdevelopment. With these actions of the capital market the base of industrialfinance has greatly widened and a large number of small investors are induced toput their savings in equity investment. Thus it is obvious that for such a purposethe existence of the stock markets become indispensable. At the time of independence, there were only a few industries in Pakistanand the related institutional framework was weak. A few insurance companiesand the managing agency systems were the only platform for trade in funds.Commercial banks were mostly engaged themselves in financing commercialoperations. The establishment of State bank of Pakistan in 1948 as the centralbank of the country laid foundation for an organized money market. The need toestablish a stock exchange was felt at the time of independence and thegovernment had taken steps to setup a stock exchange at Karachi in September 18, 1947, which was converted into a registered company limited by guaranteeon March 10, 1949. At that time it had 90 members and 13 listed companies withpaid up capital of Rs. 108 million. Though there were two other stock markets,later established in Pakistan at Lahore and Islamabad in 1970 and 1992respectively. The Karachi Stock Exchange remains the main center of activityJaved Mehboob (MBA)Final Research Report4 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE).where 75-80 % of the current trading takes place. Most of the companies Lahoreand Islamabad stock exchanges are also listed at Karachi stock exchange. Theturn over of Karachi stock exchange is fairly contributed by these two smaller but fast growing regional stock exchanges whose members send the unexecutedorders at their exchange to the Karachi stock exchange floor.The main equity market in Pakistan is Karachi Stock Exchange (KSE), has beenin operation for almost half of century. It has not been an active market until thebeginning of 1991. During the year 1994, frequent crashes of the stock marketshow that the KSE is rapidly converting into a volatile market. Heavyfluctuations in stock prices are not an unusual phenomena however, such
 
fluctuations have been observed at almost all big and small exchanges of theworld. The major fluctuation has been observed in year 2001-2002 is after the11t h September event. The stock prices have been very frequently fluctuate, andthe stock market also affected by the 10t h October 2002 Elections. Pakistan hadnuclear test on May 28, 1998 that has significant impact on KSE 100 and itdeclines from 1040.19 to 789.15 and trading volume from Rs 16 million to Rs 9Million. The recent attack of USA on Iraq have also affect the Pakistani stockmarkets in March 2003.The frequent fluctuations in the stock market have beenoccurred due to uncertainty. Focusing on the reasons for such fluctuations isintrusive, and likely to have important implications. Nevertheless, the KSEoffers an interesting set of circumstances to test the nature of market volatility.Javed Mehboob (MBA)Final Research Report5 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE).Pakistan used number of measures in order to develop its capital markets,the major measures include economic liberalization, regulatory changes inforeign exchange controls, repatriation of profits and privatization of publicsector enterprises and, most importantly, the opening of the equity market tointernational investors during 1991. However, the equity market in Pakistan islikely to regain its importance in the near future, especially in the light of major developments. Like, following the loan agreement with international monetaryfund (IMF), Pakistan has been able to receive aid inflows from many sources,such as World Bank, Asian Development Bank and Islamic Development Bankand debt rescheduling arrangements are in the process.It has been observed that in the past few years the opening of thePakistani equity market to international investors has exposed it to frequentcrashes, which indicated that the KSE, LSE, and ISE are highly volatile markets.The fluctuations in stock prices are usual phenomena and are daily observed inalmost all stock markets of the world, small as well as large.The average investors are risk averse, his/her objective is to maximizereturn with the minimum risk. Thus, given the rate of return, the stock marketsthat are relatively less volatile, are likely to attract more investment. However,what matters in the individual’s investment decision is the perception rather than realization; past experience matters to the extent that it influences futureexpectations about return and volatility. In other words, while making their investment decision investors consider expected return and expected volatilityJaved Mehboob (MBA)Final Research Report6 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE).conditional upon the available information. Thus the stock markets activities areusually governed by information. While the systematically disseminatedinformation determines the ling-term trend and underlying strength of themarket, the information that comes as a surprise event—the so called good or bad news- cause shocks to the stock markets and result in volatility. The waysinvestors interpret this news are crucial in forming expectations about the futurecourse of events in the stock markets.One relevant question is always remained on the forefront of financialtheory, why the investors take risk of volatility when a wide range of “safeassets” 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 apremium for risk that provides a sufficient incentive to take risk. This postulatehas been known as Capital Asset Pricing Model or CAMP. Although this
 
postulate has been applied time and again on almost all the major stock marketsin the world, it has not been tested thoroughly for the KSE.1.1 OBJECTIVE OF THE STUDYThe study is undertaken to address the following issues pertaining toactivities at the KSE.Javed Mehboob (MBA)Final Research Report7 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE). To verify how risk affects the selected stock prices? To verify the relationship between risk and return of selectedstocks? To verify nature of volatility in selected stocks, and how volatilityaffects the selected stock Returns?1.2 PROBLEM STATEMENTLiterature describes that there is strong relation between risk and return,and they have great impact on stock return, sometimes this impact is positiveand sometimes it is negative. It will be verified that how the risk affects thestock prices. Risk and return both are always be with stock market and have verystrong 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 toverify how the volatility affects the stock return. It is very helpful for theindividual investor to know how the stock market behaves and how the riskaffects the stock prices. This research report is very beneficial for the individualinvestor to know that how volatility affects stock return.Javed Mehboob (MBA)Final Research Report8 An Analysis of Stock Market Behavior: Risk, Return, and Stock Market Volatility InPakistan (KSE).1.3 THEORATICAL FRAMEWORKThe aim of this section is to define the relationship between the dependentand the independent variables. In this particular study, the dependent variable isreturn while the independent variable is risk.Fama and French in (June 1992): They tested stock returns over the 1963-1990 period, they found that the size and market-to-book-value variables arepowerful predictors of average stock returns. The risk and return have greatimpact on stock prices. This effect can be either an increase or decrease instock prices. This impact may be the systematic risk factors or due to theunsystematic 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 andreturn are interlinked, higher the risk depicts higher the return and lower therisk represents lower return. Farid and Ashraf (1995): describes that there was astrong positive correlation among the volume of trading, expected rate of returnand volatility of stock prices. Uncertainty leads volatility. Uncertainty andvolatility have direct relation, if the environment is highly uncertain than itleads high volatile market. Volatility is measured by the Beta. Fama and French(June 1998): describes that high beta describes that the firm is risky. Themeasure for this non-diversifiable risk is the beta coefficient -- which measuresthe volatility of an asset's returns compared to volatility of overall marketreturns. The higher the potential return, the higher the potential loss may be, andthat negative returns are possible for all investment types. Though the literatureJaved Mehboob (MBA)

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