Abstract

The purpose of this study is to determine the effects of macro-economic variables on the prices
of stock markets. Annual data from 2011 to 2020 were collected from non-financial firms listed
in the KSE-100 index. The study considered “inflation”, “exchange rate” and “GDP” as the three
independent variables while used GDP as the dependent variable. The random effect model was
used as a data analysis measure. The results showed that GDP and exchange rate were positively
co-related with the stock prices while the relationship of inflation with the stock prices was
found to negative.

1
 Acknowledgement

I pay my sincere thanks to my supervisor who guided me throughout the course of this study. I
am also grateful to my colleagues who encouraged me to keep my efforts intact throughout the
research process.

2
 Table of Contents
Abstract.......................................................................................................................................................5
Acknowledgement.......................................................................................................................................6
Chapter-1: Introduction..........................................................................................................................8
1.1. Background................................................................................................................................8
1.2. The Research Questions..........................................................................................................10
1.3. Objective of the Study.............................................................................................................11
Chapter-2: Literature Review....................................................................................................................12
Theoretical Framework..............................................................................................................................15
Chapter-3: Research Methodology...........................................................................................................17
3.1. Data and Population................................................................................................................17
3.2. Sample Size...............................................................................................................................17
3.3. Sampling Technique................................................................................................................17
Chapter-4: Results....................................................................................................................................18
4.1. Descriptive Statistics................................................................................................................18
4.2. Correlation Analysis................................................................................................................18
4.3. Regression Analysis.................................................................................................................19
Chapter-5: Conclusion..............................................................................................................................21
Chapter-6: References..............................................................................................................................22

3
 Chapter-1: Introduction

1.1. Background
The foremost function a stock market is to allow the investors to trade their shares, and other
securities which are issued by a publicly registered companies, basically it serves as a platform
for them, through which they can make an investment or convert their existing investment into
cash (Monther & Kaothar, 2010). Stock exchange indicates a country’s economy.
(Yahyazadehfar et al, 2012). This impact is marked on the economy of every nation. The past,
present as well as the future economy of a country can be drafted from the stock market
performance. As stock market is the most important way for the companies registered to raise
money by selling their shares (Zheng et al, 2010). This allows the companies to publicly trade
their shares for the ownership of the company, to raise more money for expansion.

Currently, three stock exchanges operate in Pakistan. These include “Karachi Stock Exchange
(KSE)”, “Lahore Stock Exchange (LSE)” and “Islamabad Stock Exchange (ISE)”.

The core objective for investing in capital market is to earn returns from it. Investors usually
analyze the stock trading behavior to earn maximum expected returns. “Stock returns” is defined
as “the capital profit or loss as a result of making investments in the stock market” (Jones, 2000).
Stock returns change in stock markets daily. Earning from a given stock helps the investors to
forecast the future benefits (earnings) with certain risk involved, from that stock (Dimitropoulos,
2009), it also stated that stock return is the measure of shareholder wealth in the security
exchange. Moreover, these stock returns are the measure of shareholder wealth in the stock
exchange. (Mwaurah, 2017).

When there is a decrease in stock returns it will result in losses for the investor due to which their
interest in investing in that sector or company decreases. Investors expect a high return with the
level of risk that they will face. So, it is very much important for investors to do some analysis
before investing (Wijaya and Sedana, 2020). For determining decisions regarding investment
two approaches can be made naming technical and fundamental analysis. Fundamental analysis
comprises of firm’s performance and projections to estimate the stock price of that firm. It

4
consists of three phases which are macro-economic analysis, industrial analysis, and company
analysis. (Tandelilin, 2010: 339).

Microeconomics tells that how efficient resources are utilized and distributed in a company. It
mainly focuses on the in-company operations, like firm performance. According to Brigham;
2000, liquidity ratios are used to measure ability of a company to meet its short-term debt. This
study will be using a current ratio as a proxy for liquidly ratios. Profitability ratio is used to find
a firm’s profit from its assets and equity (Stefano 2015). Return on Asset and Return on Equity
will be used as proxy for profitability ratio. The firm size is an element that should be considered
by investors to make a decision whether a company is small, medium, or large company
(Handayani, 2019). The criteria of firm size can be examined through its sale, the number of
products, capital resources, and total asset (Jogiyanto, 2003).

Macro variables cannot be ignored while valuing stocks because the macro-economic variables
also affect the performance of stock market. Inflation, interest rates and exchange rates are
among those which affect the stock markets. Most of the researches confirm the relationship
between stock prices and the macro-economic variables. These variables change due to the
government policies of a country, so all the companies in the country gets affected due to this
change. Previous studies have found a negative co-relation between inflation rate and stock
prices due to the fact that varying/ high inflation rate creates uncertainty in a country, which will
create a minimum returns due to which there will be a decrease in the market value, as proved by
Sohail and Hussain (2009). Interest rate directly relates to the economic growth of a company.
Generally, rate of interest is termed as “cost of the capital”; it is the price that is paid to the
owners for the use of their money for a particular period. Some studies like those conducted by
Erdem et al., 2005 and Lobo, 2002, have also reported a positive relationship between the stock
prices and interest rate.

5
1.2. The Research Questions
The following research questions have been addressed in this research study.

a. Does inflation influence stock price?

b. Does exchange rate influences stock price?
c. Does GDP influence stock prices?

6
1.3. Objective of the Study
This purpose of this research study is to evaluate the influence of exchange rate, inflation, and
GDP on the stock returns. The results would assist investors to evaluate and predict stock return
of the KSE listed companies. This research would tell its readers about the trends and behavior
of different macro-economic variables with stock exchanges. The research is based on finding
how each variable affects the stock returns. Whether, it has a positive or negative effect.

7
 Chapter-2: Literature Review

The relationship of macroeconomic scope money related factors with Indian monetary trade was
analyzed and vector-botch association model was used (Naik and Padhi; 2009). The results
showed effects of full scale financial components on stock returns. To notice the effect of full
scale monetary factors on stock returns in Kenya, Aroni used backslide formula to focus on this
relationship. The results showed enormous effects of huge scope money related factors on stock
returns. An investigation focus on drove in Peshawar (Aroni; 2010) similarly inspected the
impact of full scale financial factors on stock returns. Different backslide model was used. The
assessment showed a unimportant effect of stock returns (Khan, Sangeen, Rukh, Imdadullah and
Rehman; 2010). In Pakistan another survey drove perceived the relationship of full scale
financial elements with stock returns. A negative association was seen among extension and
stock returns, while a positive co-association was found between "supply of money" and
"transformation scale" (Sohail and Hussain; 2011).

(Kuwomu and Victor; 2008) In an audit the relationship in Ghana was examined. Yearly data
from 1992 to 2008 was used. The results showed development rate and transformation standard
had an immense relationship while cash supply showed an unfavorable outcome. In another
survey, Augmented Dickey Fuller Test (ADF Test), transient association between enormous
scope money related factors and stock returns was found in the Republic of Lithuania. The data
from the year 2000 to 2009 has been used in the audit. They saw that money supply
unequivocally affected the stock expenses. Additionally change scale and credit expense
antagonistically affected monetary trade costs (Pilinkus and Boguslauskas; 2009).

(Yogaswari, Nugroho and Astuti; 2011) The co-relationship of enormous scope financial
elements with the stock expenses was investigated in an audit in Indonesia as well. Various
backslide assessment (a genuine technique used to take apart the association between a lone ward
variable and a couple of independent elements) was used to take a gander at the relationship of
full scale financial factors and returns from the protections trade. The investigation study has
addressed that speed of exchange, extension, GDP, and credit cost cause basic impact on the
stock expenses. Development has advantageous result while, supporting expense unfavorably
impacts the stock returns. Another audit shows the relationship between full scale financial
8
factors in China's stock returns. To review the association between the picked factors, the
assessment used the Autoregressive Distributed Lag (ARDL) model. The survey point by point
that there was a constructive outcome of extension rate on stock returns. The examination
similarly found that speed of income, cash supply, GDP, imports and items also impact the stock
gets back through and through. (Bellalah, Masood, Darshini, Levyne & Triki; 2009).

A survey dispersed in the International Journal of Economics and Financial Issues (Vol. 2, No. 4,
2012) has uncovered a survey (Economic Forces and the Stock Market) that has attempted the
attention to enormous scope monetary components on stock returns using the Arbitrage Pricing
Theory (APT) proposed by Ross (1976). They noticed a strong association between protections
trade returns and full scale monetary components. For both short and long stretch funding
expenses, and development rate. Like (Nai-Fu Chen et al; 1986), one more investigation
moreover found an association between stock returns and the full scale monetary components.
These disclosures are solid with the Japanese market as well (Hamoa; 1988). The results of an
investigation focus on that has reviewed the United Kingdom market has shown that not at all
like the US market, the full scale monetary factors essentially influence share returns in the
United Kingdom. The audit assumes that either interesting full scale money related factors
meaningfully affect share returns in the UK the framework used by Nai-Fu Chen, Richard Roll
and Stephen A. Ross is inefficient (Poon and Taylor; 1991). Actually various observational
models were used without giving a particular speculative arrangement, in a practical technique
for finding the association among expenses and full scale financial components (Groenwold;
2004). One of the popular models is the Multivariate Vector Autoregressive (VAR) approach. In
this space the new model found is (Yin-Wong Cheung and Lilian K. Ng1998) and (Gjerde and
Saettem; 1999).

George Hondroyiannis and Evangelia Papapetrou; 2001 examined the examples of

characteristics of money related elements' effects on the stock returns in Greece. The survey use
VAR examination method for managing focus on the effects of enormous scope financial
variables on stock returns. The audit considered month to month data of Greece as obtained for
the years 1984 to 1999.

The results of this study show that monetary development of the local market in a general sense
impacts protections trade execution. In another assessment focus on the connection between's

9
stock returns in the ASEAN-5 countries (Indonesia, Malaysia, Philippines, Singapore and
Thailand) were had a go at using five huge scope money related factors. They saw the short and
long run association between stock records and full scale monetary components including the
money supply, buyer cost document, credit charge, and change standard. The audit showed that
long term all the five stock worth records were associated unequivocally to improvement and
antagonistically to the hard and fast expense. Of course, for a really long time, negative
corelation was seen between stock expenses and credit charges for Philippines, Singapore and
Thailand and a positive relationship for Indonesia and Malaysia (Praphan Wongbangpo and
Subhash C. Sharma; 2002) (Kenneth R. French et al; 1987) in their assessment study "Expected
stock returns and precariousness" showed that stock returns answer antagonistically to both long
and flashing supporting expenses. On the other hand (Linda Allen and Julapa Jagtiani, 1997)) in
their audit have contemplated that supporting costs mindfulness with stock returns had decreased
immovably during the last piece of the 80s and mid 90s. In addition; (Bulmash and Trivoli;
1991) addressed that stock expenses and Treasury bills were antagonistically related. An audit
analyzed little business areas, and showed that stock returns were noting conversely to changes
in credit costs (Gjerde and Saettem; 1999; Achsani and Strohe; 2002). Another audit overviewed
the effects of enormous scope monetary variables on the stock expenses in Stock Exchange of
Istanbul (Turkey) for the period from July, 1997 to June, 2005. The survey used a plan of stocks
rather than a single stock. The assessment has itemized colossal effects of funding cost in finding
stock returns (Kandir; 2008).

(Gay; 2008) assessed four making markets and analyzed the time relationship of stock returns,
full scale financial elements and transformation standard. He used 'BoxJenkins ARIMA' model
and uncovered no huge association between transformation scale and stock returns in any of the
recently referenced four countries. Another survey drove by (Fama and Schwert; 1977) wrapped
up a negative association between stock returns and T-bills rates. Another assessment has
itemized the effects of changes in advance expense on the benefits of monetary trade return; the
survey has used yearly data secured for the period from 1991 to 2012. The Johansen
Cointegration Test (Johansen Test) shows that long term, the credit cost has a basically
unfortunate relationship with the stock returns (Mukit; 2012). The Granger Causality Test
uncovers that unidirectional causality exists from supporting expenses and stock returns. One
more actually coordinated research survey for Bangladesh economy has explored the monetary

10
effects of advance charges on protections trade capriciousness; delayed consequences of the test
revealed a critical and predictable relationship between the elements. It was similarly seen that
1% climb in the supporting expense causes 13.20% lessening in the market document. Here
moreover, the results of the Granger Causality Test insist the presence of a unidirectional
relationship (Muktadir-al-Mukit; 2013).

Kasman, S. (2003), in his study “The Relationship Between Exchange Rates and Stock Prices: A
Causality Analysis”, used high repeat data and saw colossal association between change scale
and stock returns for the monetary trade of Turkey,. As shown by the attempted evidence from
the eventual outcomes of Johansen Approach, an involved acquaintance exists between stock
returns and the change standard. Moreover, the disclosures of the Granger Causality Analysis
have included a unidirectional association between trading scale and stock returns. As regards
the monetary trade of India, examiners have studied the association between the transformation
scale and monetary trade returns. These results have dismissed that there was any causal
association between the two elements. In the new times, a survey has noticed strong causal
relationship from monetary trade returns to new exchange market returns (Nath and Samanta;
2003).

Basically, in "The Relationship between Exchange Rates and Stock Prices: The Case of Mexico
", Gopalan Kutty has focused on the trial relationship of trading scale with stock returns for
Mexican's protections trade. The outcomes of the test have exhibited that there is no huge time
span association between the focused on data. Regardless, the Granger Causality test has shown
short-run connection between the data. Another audit coordinated by Tarun K.
Mukherjee,Atsuyuki Naka in Tokyo (Japan) has noticed a relationship between enormous scope
monetary factors and stock returns using a social occasion of determinants. Disclosures of the
Error Correction Model (ECM) has recognized that a positive relationship of the stock returns
exists with the change standard, cash supply and GDP (Mukherjee & Naka; 1995).

11
12
 Theoretical Framework

Independent Variables Dependent Variable

GDP

Exchange rate

Stock Returns
Inflation rate

13
 Chapter-3: Research Methodology
3.1. Data and Population

Yearly panel data about the study variables for six years starting from December 2011 to
December 2020 is collected for all the variables. Data about the macro-economic variables is
collected from sources which are Yahoo Finance, State Bank of Pakistan, The Business
Recorder, Karachi Stock Exchange, Investment.com and Federal Bureau of Statistics. Data about
the historical prices of the stocks is collected from PSX website.

3.2. Sample Size

The sample size used in this research was KSE 100 companies. Many researches like Haroon
(2013), Farooq (2006) and Safwan (2009) has used KSE 100 companies for their researches, this
is because KSE 100 can show the overall image of all the stock market.

3.3. Sampling Technique

Since the overall population of this study is known and accessible therefore the study has used a
purposive sampling method, to select only those companies which meet the criteria specified by
the researcher for a better result. The criteria used consist of:

a. All non-financial companies listed on the KSE100

b. Non-financial companies listed on the KSE 100 that had presented the required research
data in full during 2011-2020.

14
 Chapter-4: Results

4.1. Descriptive Statistics

Observatio STD. Maximu

Variables n Mean Dev. Minimum m
0.047457 - 0.372670
0.001334 7 0.7962245 8
Returns 1,100 3
Inflation 1,100 7.225622 3.072576 2.529328 11.91609
Exchange 112.916 23.31263 86.34338 161.8385
rate 1,100
GDP 1,100 2.62e+11 3.20e+10 2.14e+11 3.15e+11

Table 1

The main objective of the study was to assess the impact of dividend policy and firm
performance on shareholders' capital. In this regard, variables like GDP, rate of exchange and
rate of inflation to Stock returns were considered and duly examined. Initially, descriptive
statistics were performed on the aforementioned variables, as shown below:

Table:1 displays the descriptive statistics. The mean of the observed variables is GDP (mean =
2.62e+11), Exchange rate (mean = 112.916), Inflation rate (mean = 7.225622), and Stock returns
(mean = 0.0013343). From the above statistics, it can be observed from the standard deviation
that Exchange rate standard deviation is well above normal, and GDP standard deviation is well
below normal level.

4.2. Correlation Analysis

Exchange
Variables Returns Inflation rate GDP
Returns 1.0000
Inflation -0.0408 1.0000

15
Exchange 0.2098 1.0000
rate 0.0221
GDP 0.0447 -0.6308 0.4284 1.0000

Table 2
Table 2 shows the association examination of the elements. The going with table sees that there
is a strong negative association among GDP and Inflation (Pearson correlation coefficient = -
0.6308).

4.3. Regression Analysis

Regression Model (Stock returns as Dependent Variable)

Hausman Test
Chi Square 16.570801
Df 4
Prob (F-Statistics) 0.0023
Table 1 FEM

As the P-value in the Hausman test is less than 5%, so we can run Fixed effect regression to
analyze the effect of Stock Returns as a dependent variable.

xtreg Returns Inflation Exchange Rate GDP, fe

Fixed-effects (within) Number of obs = 1,100
Group variable: Code Number of groups = 110

R-sq: Obs per group:

within = 0.0030 min = 10
between = 0.1030 avg = 10.0
overall = 0.0027 max = 10

16
 F(3,987) = 0.99
corr(u_i, Xb) = -0.0000
Prob > F = 0.3964

Returns Coef. Std. Err. t P>|t| (95% Conf. intrerval)

Inflation -.0006955 .0008166 -0.85 0.0845 -.0022981 .000907
Exchange .0000924 0.66 0.0464 -.00012 .0002427
rate .0000613
GDP 5.03e-15 8.49e-14 0.06 0.03456 -1.62e-13 1.72e-13
Cons -.0018844 .0207083 -0.09 0.928 -.0425216 .0387527

.0161585
4
.0470403
Sigma-u 7
Sigma-e .1055414
Rho 7

Fixed effect regression shows that when Stock returns is taken as a dependable variable then
GDP and Exchange rate show a significant effect on the shareholder's wealth. Their coefficient
shows the relation between the dependent and independent variable, here it has a positive value
for GDP and Exchange rate which means increasing the GDP of a country and Exchange rate
will increase the Stock returns of its exchange.

17
 Chapter-5: Conclusion

In this focus on the effects of full scale financial variables on stock returns have been penniless
down. The eventual outcomes of this study show that GDP and transformation standard firmly
influence stock returns however the extension unfavorably influences stock returns. This is in
light of the fact that when extension gets more huge remunerations and other compensation
sources get decreased, which reduces the purchasing power of people. Monetary patrons quit
placing assets into protections trades and things being what they are start placing assets into
items that are upheld by extension, similar to gold. Likewise change scale and GDP have
positive relationship with the stock returns. Whenever the speed of exchange and GDP are
higher, the monetary supporters put to get more advantages which accordingly increase stock
expenses. As the interest increases costs furthermore increase.

Recommendations

The researcher has conducted the research on factors effecting stock prices on KSE-100 index
non-financial companies. Data was used from 2011 till 2020 by using three independent
variables.

If anyone is conducting a research on the same topic he/she may note the following

a. The researcher must use more independent variables

b. Time limit should be increased
c. The sample size should be increased

18
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