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European Journal of Scientific Research ISSN 1450-216X Vol.38 No.1 (2009), pp.96-103 EuroJournals Publishing, Inc. 2009


Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
Suliaman D. Mohammad Associate professor, Federal Urdu University of Arts, Science and Technology E-mail: Adnan Hussain Visiting Lecturer, Federal Urdu University of Arts, Science and Technology E-mail: Adnan Ali Student of M.Phil, Applied Economics Research Centre, University of Karachi E-mail: Abstract The object this paper is to find the relationship between macroeconomic variables and prices of shares in Karachi stock exchange in Pakistan context. We considers the quarterly data of several economic variables such as foreign exchange rate, foreign exchange reserve, industrial production index, whole sale price index, gross fixed capital formation, and broad money M2 , these variables are obtain from 1986 to 2008 period . We try to make link these macroeconomics variables to stock prices. Compared to earlier work we have used multiple regression analysis and compare the results. The results shows that after the reforms in 1991 the influence of foreign exchange rate and reserve effects significantly to stock market whiles other variables like IIP and GFCF are not effects significantly to stock prices. so our result shows that internal factors of firms like increase production and capital formation not effects significantly while external factors like exchange rate and reserve are effects significantly the stock prices. So the after post reforms period is positively effects stock prices. The study will be very help full for national policy makers, researchers and corporate managers etc.

I. Introduction
The stock market is supposed to play an important role in the economy in the sense that it mobilizes domestic resources and channels them to productive investments. However, to perform this role it must have significant relationship with the economy. Capital markets are key elements of a modern, marketbased economic system as they serve as the channel for flow of long term financial resources from the savers of capital to the borrowers of capital. Efficient capital markets are hence essential for economic growth and prosperity. With growing globalization of economies, the international capital markets are also becoming increasingly integrated. While such integration is positive for global economic growth, the downside risk is the contagion effect of financial crisis, especially if its origin lies in the bigger markets. As for the effect of macroeconomic variables such as money supply and interest rate on stock prices, the efcient market hypothesis suggests that competition among the prot-maximizing investors

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)


in an efcient market will ensure that all the relevant information currently known about changes in macroeconomic variables are fully reected in current stock prices, so that investors will not be able to earn abnormal prot through prediction of the future stock market movements (Chong and Koh 2003). Therefore, since investment advisors would not be able to help investors earn above-average returns consistently, except through access to and employing insider information, a practice generally prohibited and punishable by law, there should be no stock broking industry, if one were to believe the conclusions of the EMH. Stock market is a critical cog in the wheel that smoothens the transfer of funds for economic growth. Broadly speaking, stock exchanges are expected to accelerate economic growth by increasing liquidity of financial assets and making global risk diversification easier for investors promoting wiser investment decisions. In principle, a well functioning stock market may help the economic growth and development process in an economy through growth of savings, efficient allocation of investment resources and alluring of foreign port folio investment. The stock market encourages saving by providing households having invest able funds, an additional financial instrument, which meets their risk preferences land liquidity needs better, it in fact provides individuals with relatively liquid means for risk sharing in investment projects. (agrawalla 2006).

II. History of KSE (Karachi Stock Market)

Since after independence in 1947 a multitude of problems have stood in Pakistan way of realizing its true economic potential. Include in the social and political problems are sectarian violence, increasing population, archaic bureaucratic procedures and political instability. Economic problems have include counter productive tax rated, debilitating customs duties that reduce foreign investment and the Pakistani government strategic approach that kept the economy as well as the stock market closed to foreigners. Although Pakistan continues to struggle with socio-political problems it has recently made tremendous strides in the economic front via reforms that were introduced in the early part of 1991. The most significant of the reforms was perhaps investment on very liberal terms and allowing for the first time after the independence of Pakistan history direct and indirect investment by foreign nationals and international investor in Pakistan equity market. These reforms have produced positive results. Karachi stock exchange is largest and most active stock market in Pakistan accounting for between 65% and 70 % of the value of the country total stock transaction as on October 1, 2004, 663 companies were listed with market capitalization $23.23 billion having listed capital of us $ 6.59 billion. Pakistan's industrial exports and foreign investment today are growing at the country's fastest rate ever. The country's foreign exchange reserves skyrocketed to $12327.9 million in 2003-04 from $2279.2 million in 1998-99. Similarly, several Pakistani stocks are now traded on international markets. Also, foreign brokerage houses are now being allowed through joint ventures with Pakistani investment bankers to participate in primary as well as secondary markets in Pakistan. Given the newfound interest in the Pakistani stock markets, an intriguing question is how these markets have performed over the years. To answer this question we examine the return generating process of the Karachi Stock Exchange (KSE). Karachi Stock Exchange is the biggest and most liquid exchange in Pakistan. It was declared the Best Performing Stock Market of the World for the year 2002. The KSE 100 Index touched at 5245.82 on October 01, 2004. KSE has been well into the 3rd year of being one of the Best Performing Markets of the world as declared by the international magazine Business Week. Similarly the US newspaper, USA Today, termed Karachi Stock Exchange as one of the best performing bourses in the world. Karachi Stock Exchange achieved a major milestone when KSE-100 Index crossed the psychological level of 15,000 for the first time in its history and peaked 15,737.32 on 20 April, 2008. Moreover, the increase of 7.4 per cent in 2008 made it the best performer among major emerging


Suliaman D. Mohammad, Adnan Hussain and Adnan Ali

markets but due to current global financial crisis it can be declined to 9,000 because foreign capital out flows increase very sharply. As of Sept25, 2009, 654 companies were listed with a market capitalization of Rs. 2.806 trillion (US$ 33.81 billion) having listed capital of Rs. 705.873 billion (US$ 10.615 billion). The KSE 100TM Index closed at 9359 on Sept 29, 2009. In section 3 we have analysis some previous work done in this regard as review literature in section 4 we define some variables which used in study and define data set. In section 5 we define econometrics methodology which we used in study in section 5 we concluded result form this study and finally in section 6 we concluded our study report

III. Literature review

There is lot work has been done so far in this regard. Now we have overview some of economist works in this section of the paper as review literatureThe hypothesis the change in macro economics variable have got strong impact on assets prices as subject extensive research Dr. Nishat (2004) analyze long term relationship between macroeconomic variables are stock price. He used CPI, IIP, money supply and foreign exchange rate as explanatory variable in this paper result indicates are causal relation between the stock price and economy. He used Karachi stock exchange 100 index price for 1974 to 2004. Analysis of his work found that industrial production index is largely positively significant while inflation is significantly negatively related he used granger causality test to determined effect the above said variables to stock price he found that interest rate is not cause scientifically to stock price. He used unit root technique to make data stationary. Shahid Ahmed (2003) has worked on SENSEX index price effects by real and financial sector performance in economy for the period 1997 to 2007. he used variables export and foreign exchange rate and foreign direct investment. He used methodology of granger causality test he finding are all variables are significantly effect stock price. He found the data is not stationary which sign that there is speculation in stock market he run AR which has high significance value Fazal Hussain and Tariq Masood (2001) they used variable investment, GDP and consumption and used granger casualty test to define the relation ship between these variables to stock price there finding on two lags above said variables highly significant effect on stock prices Robert D. gay (2008) he used MA method with OLS to find relation ship between stock prices and macro economics variables effects on four emerging economies India, Russia, Brazil and China. He used oil price, exchange rate, and moving average lags values as explanatory variables but result are insignificants which shows inefficiency in market final conclusion is that these economies are emerging so domestics factors more influence outside factors oil price and exchange rate Dr. Aftab(2000). He try to link between monetary and fiscal policy of Pakistan equities market and the result of his analysis is significant. He found that fiscal and monetary policy change market capitalization through equity (changes floated shares) and liquidity which can significantly causal relation shows with market capitalization/ stock price. In case of Pakistan data set is used 1993 to 1998 Liaquat Ali and Nadeem Ahmed(2008) they used data 1971 to 2006 and try to make relation ship of economic growth with stock market prices they found the dynamics relation ship between stock prices and economic growth. They employed DF-GLS test first time in case of Pakistan. M.Shahbaz (2006) he tries make relationship between stock prices and rate of inflation he used ARDL model which used dynamics analysis. His finding are stock hedges against inflation in long run but not in short run and discuss black economy which effect long run and short run prices of the stock he used variables CPI, as proxy of inflation and share of black economy the sample size he took 1971 to 2006. Safail Sharma (2007) he used rate of interest, exchange rate, industrial production index, money supply and inflation as explanatory variables he used AR and MA as also explanatory variable to remove effects of non stationary in the data. His finding are lags values are highly correlated with current prices suggest speculation in market. Exchange rate, industrial production index and money supply is significantly related he took data set 1986 to 2004.

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)


Song-zan-chiou-wei(2000) he used money supply oil price and exchange rate as explanatorily variables for Asian stock market he used VAR model applied to observed the differences of the structure of fluctuation after 1997 financial crises. His finding oil prices and inflation are highly effect the stock market of Asian economy Desislava Dimintrova (2005) he used exchange on stock prices by multivariate model he link exchange rate with economic policy (fiscal and monetary policy) with exchange rate and found relation with stock prices he defines interest parity condition effect on stock prices his results shows unambiguous effects on deprecation of stock prices on exchange rate deprecation

IV. Econometrics methodology and Data base

4.1. Data Base The assets valuation model and pricing of macroeconomics variables Stock prices and foreign exchange rate and reserve: stock prices relation ship regarding to foreign exchange is suggest to be decreasing/ increasing due to liberalization of stock market in any economy foreign direct investment will increase valuation of return and prices are as follows.
= + / r + = ps

Where = is total gain which equal to price of share = net dividend / profit = capital gain r = real interest rate = risk premium ps = price of shares As liberalized stock market it can cause reduced risk premium and increase competition in stock market which increase stock prices. Due to increase inflow of foreign exchange currency its supply increases it can cause to appreciate local currency so price of share increase due to improve foreign exchange reserve it cause exchange rate appreciate while other remain constant Stock prices and interest rate: increase in interest rate cause to increase opportunity cost of holding money which can substitution between stock and interest bearing securities and cause falling stock prices and another reason for falling stock prices is that when increase in interest rate it can cause increase in cost of production it can detorate companies profit and dividend which can reduced prices of shares it may also argued that the effect of discount rate would be negated if cash flows increase in same rate as inflation. How ever cash flow go not up with inflation other economy suggest pre existing contract would deny any immediate adjustment for firms revenue and cost Stock market and money supply: the direction of impact of monetary growth is negative because increase money supply increase in inflation so people maintained there real cash balance so they sells share and other assets which cause decline in share prices but on other hand increase monetary growth reduce interest rate which reduce cost of capital and increase earning of corporation. So we have found ambiguous effects. Industrial production index and stock prices: the direction IIP and stock prices are positive relation ship because increase IIP shows the increase in production of industrial sector which increase profit of industries and corporation. As dividend increase and share prices are increases so positive relation is found between IIP and share price Gross fixed capital formation and share price: gross fixed capital formation is defined as fixed assets accumulation. Assets accumulation increase by bond finance and equity finance if


Suliaman D. Mohammad, Adnan Hussain and Adnan Ali

cooperation wants to finance assets they floats share so supply of share increase and decline share prices or other ways increase assets finance by bond then firm/corporation credit worthiness decline which cause decline firm share prices so theory says increase Gross fixed capital formation decline share price in short run but in long run production increase cause increase share price so we can says ambiguous effects of share prices We have taken the data of sample period of above said variables from 1986 and 2007 to analysis the effects on share price. The logic behind taken the sample period between 1986 to 2007 is that in 1991 the reform of financial sector is start and it can cause liberalized stock market. 4.2. Econometrics methodology In our study we have taken time series data for econometrics analysis several preliminary statisitical steps must be taken the step included descriptive statistics, unit root, and auto regressive integrated moving average (ARIMA) model testing. The nature of time series data, it is necessary to test stationary of each individual variable. Stationary menas mean and variance between two time periods deapnd only on the distance or lag between the two time periods and not on the actual time at which co variance is computed to check the stationary ADF (augmented dickey fuler) test. It consists of regressing level and firest difference of the time series against constant The model used is as follows r = + rt j + at + rt 1 + we set the null hypothesis no stationary and alternative hypothesis is staionary and check all the variables stationary by ARIMA to make them stationary. We have finally the model SP = + 1 EXR + 2 IR + 3 IIP + 4 GFCF + 5 M 2 + 6 EXRR + In the above equation is constant and is coefficient of variables while is normally distributed error term

V. Result Analysis
The empirical result or evidence provided by the various studies mentioned in the section of review literature is shows that macroeconomics variables have strong effects on the stock market. In other words national stock market is said to be information ally inefficient with respect to most macroeconomics variables. If market is inefficient with respect to information then it has important implication both at micro and macro level. As evident in table no. 1
Table 1:
SP 127.6368 103.56 299.21 34.57 78.14981 0.972571 2.73852 14.12381 0.000857 88 EXCRES 3553.989 1322 14435 213 4217.17 1.163066 2.669788 20.23975 0.00004 88 EXR 39.89068 39.765 64.15 15.98 16.81541 0.019702 1.386929 9.546355 0.008453 88 GFCF 110574.6 89578.5 396551 17259 88349.3 1.241375 4.173968 27.65491 0.000001 88 IIP 105.5122 92.29 232 52.52 43.29091 1.104169 3.264533 18.13803 0.000115 88 IR 8.030114 7.89 15.42 1.05 3.050957 0.175299 2.924647 0.471524 0.789969 88 M2 400084.3 395424 1043700 69875.9 280527.7 0.411707 2.089966 5.522628 0.063209 88 WPI 81.3842 84.305 164.25 27.94 38.89997 0.274529 1.960819 5.064995 0.07946 88

mean median maximum minimum Std. Dev. Skewness Kurtosis Jarque-Bera probablity observation

As we saw in above table no.1 it can shows that all the variables are positively skewed which shows that they are asymmetrical. Kurtosis value of all variables also shows data is not normally distributed because values of kurtosis are deviated from 3. So the descriptive statistics shows that the values are not normally distributed about its mean and variance or other word we can says no

Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)


randomness in data and therefore, being sensitive to speculation shows periodic change. This indicated that individual investor can earn considerably higher normal rate of profit from the Karachi stock market. So the results of above descriptive statistics raise the issue the inefficiency of market. The funds of market are not allocated to the productive sector of the economy. The result of unit roots test suggested that data/variables is not stationary at level except gross fixed capital formation other wise all variables are not stationary at level but they are stationary at first difference level. The value is 5% level significant of first difference level. We have used ADF (augmented dicky fuller) method used to find stationary of data as suggested in section 5 of this paper.
Table 2: Unit root test
At level -1.426297 3.311289 -1.335140 -1.647429 1.797305 -1.621632 -0.978078 -0.250161 At first difference -3.923520* -5.618675* -4.189409* -9.058792* -13.81579* -4.723153* -6.420688* -4.120358*

Variables Share price Gross fixed capital formation Foreign exchange reserve Interest rate Industrial index of production Whole sale price index (wpi) M2 (Broad Money) Foreign Exchange rate *significance level at 5%

Table 3:

Dependent Variable: SP
Coefficient 462.2149 0.983048* 0.983110* Std. Error 729.6082 0.035285 0.012342 t-Statistic 0.633511 27.85994 79.65724 Prob. 0.5281 0.0000 0.0000

Variable C AR(2) MA(1) Significance level at 5%

As evident from above table Karachi stock share prices are autoregressive of order 2 and highly significant and moving average is also very highly significance shows that prices are highly seasonal. Thus while studying the impact of macroeconomics variables lagged prices of Karachi stock exchange are also taken as independent variables.
Table 4: Dependent Variable: SP
Coefficient 50.93326 0.004599** -2.645900* -0.000134 0.151023** -1.242176* -3.59E-05* 2.411239* 0.820881* 0.989783* Std. Error 47.72902 0.002749 1.125605 9.09E-05 0.086775 0.595195 1.86E-05 0.813718 0.075523 0.001822 t-Statistic 1.067134 1.673216 -2.156000 -1.471965 1.740394 -2.087007 -1.931914 2.963239 10.86930 543.0924 Prob. 0.2893 0.0984 0.0356 0.1452 0.0858 0.0402 0.0571 0.0041 0.0000 0.0000

Variable C EXCRES EXR GFCF IIP IR M2 WPI AR(2) MA(1) *significance level at 5% **significance level at 10%

Further analysis also as reported in table no. 4 foreign exchange rate is highly significance at 4% level. It found that negative relation with KSE which shows that foreign institution investment has been significant factor in moving the stock market price as foreign investment increase reserve of foreign exchange also increases so exchange reserve is positively related with stock price at 10%


Suliaman D. Mohammad, Adnan Hussain and Adnan Ali

significance level. IIP are also significance at 9% level which suggested that as industrial production increase stock prices are increase. Interest rate is negatively related to stock prices as interest rate increase stock price fall down as we define section 4.1. Interest rate is significantly effect at 4% level. M2 is negatively related to stock prices and significant at 6% level.

VI. Conclusion
The finding of this research paper is that the hypothesis suggests that the changes in the macroeconomics variables cannot be used as a trading rule by investors to earn consistently abnormal profits in the stock market. Current as well as past information on the growth on the variables are fully reflected in assets prices so that investors are unable to formulate some profitable trading rule using the available information. The main objective of the present paper is to study the relationship between macroeconomics variables and Karachi stock market. We have used quarterly data of foreign exchange rate, foreign exchange reserve, gross fixed capital formation, M2, call money rate (interest rate proxy), Industrial production index and whole sales price index (proxy of inflation). The result shows that exchange rate and exchange reserve and highly affected the stock prices. We have saw that after liberalization in 1991 of stock market in Pakistan has largely increase stock prices in Pakistan. The empirical result also suggests that IR and M2 is also significant and effect negatively to stock prices. However, few variables like IIP and GFCF are neglect able effects to stock prices so result suggested that increase capital formation by firms and increase industrial production not affects stock prices.

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