Impact of Macroeconomics Variables on Stock Prices Emperical Evidance in Case of Kse Karachi Stock Exchange

8/6/2019 Impact of Macroeconomics Variables on Stock Prices Emperical Evidance in Case of Kse Karachi Stock Exchange

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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)

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

E-mail: [email protected]

Adnan HussainVisiting Lecturer, Federal Urdu University of Arts, Science and Technology


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


Abstract

The object this paper is to find the relationship between macroeconomic variablesand prices of shares in Karachi stock exchange in Pakistan context. We considers thequarterly data of several economic variables such as foreign exchange rate, foreignexchange 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 . Wetry 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 thatafter the reforms in 1991 the influence of foreign exchange rate and reserve effectssignificantly to stock market whiles other variables like IIP and GFCF are not effectssignificantly to stock prices. so our result shows that internal factors of firms like increaseproduction and capital formation not effects significantly while external factors likeexchange rate and reserve are effects significantly the stock prices. So the after postreforms period is positively effects stock prices. The study will be very help full fornational policy makers, researchers and corporate managers etc.

I. IntroductionThe stock market is supposed to play an important role in the economy in the sense that it mobilizesdomestic resources and channels them to productive investments. However, to perform this role it musthave significant relationship with the economy. Capital markets are key elements of a modern, market-based economic system as they serve as the channel for flow of long term financial resources from thesavers of capital to the borrowers of capital. Efficient capital markets are hence essential for economicgrowth and prosperity. With growing globalization of economies, the international capital markets arealso 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 ef cient market hypothesis suggests that competition among the pro t-maximizing investors


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

in an ef cient market will ensure that all the relevant information currently known about changes inmacroeconomic variables are fully re ected in current stock prices, so that investors will not be able toearn abnormal pro t 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 returnsconsistently, except through access to and employing insider information, a practice generallyprohibited and punishable by law, there should be no stock broking industry, if one were to believe theconclusions of the EMH.

Stock market is a critical cog in the wheel that smoothens the transfer of funds for economicgrowth. Broadly speaking, stock exchanges are expected to accelerate economic growth by increasingliquidity of financial assets and making global risk diversification easier for investors promoting wiserinvestment decisions. In principle, a well functioning stock market may help the economic growth anddevelopment process in an economy through growth of savings, efficient allocation of investmentresources and alluring of foreign port folio investment. The stock market encourages saving byproviding households having invest able funds, an additional financial instrument, which meets theirrisk preferences land liquidity needs better, it in fact provides individuals with relatively liquid meansfor 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 itstrue economic potential. Include in the social and political problems are sectarian violence, increasingpopulation, archaic bureaucratic procedures and political instability. Economic problems have includecounter productive tax rated, debilitating customs duties that reduce foreign investment and thePakistani government strategic approach that kept the economy as well as the stock market closed toforeigners.

Although Pakistan continues to struggle with socio-political problems it has recently madetremendous 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 thefirst time after the independence of Pakistan history direct and indirect investment by foreign nationalsand 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 forbetween 65% and 70 % of the value of the country total stock transaction as on October 1, 2004, 663companies were listed with market capitalization $23.23 billion having listed capital of us $ 6.59billion. Pakistan's industrial exports and foreign investment today are growing at the country's fastestrate 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 internationalmarkets. Also, foreign brokerage houses are now being allowed through joint ventures with Pakistaniinvestment bankers to participate in primary as well as secondary markets in Pakistan. Given thenewfound interest in the Pakistani stock markets, an intriguing question is how these markets haveperformed over the years. To answer this question we examine the return generating process of theKarachi Stock Exchange (KSE).

Karachi Stock Exchange is the biggest and most liquid exchange in Pakistan. It was declaredthe Best Performing Stock Market of the World for the year 2002. The KSE 100 Index touched at5245.82 on October 01, 2004. KSE has been well into the 3rd year of being one of the Best PerformingMarkets of the world as declared by the international magazine Business Week. Similarly the USnewspaper, USA Today, termed Karachi Stock Exchange as one of the best performing bourses in theworld.

Karachi Stock Exchange achieved a major milestone when KSE-100 Index crossed thepsychological 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


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98 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 outflows increase very sharply. As of Sept25, 2009, 654 companies were listed with a marketcapitalization 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 insection 4 we define some variables which used in study and define data set. In section 5 we defineeconometrics methodology which we used in study in section 5 we concluded result form this studyand finally in section 6 we concluded our study report

III. Literature reviewThere is lot work has been done so far in this regard. Now we have overview some of economist worksin this section of the paper as review literatureThe hypothesis the change in macro economics variablehave 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 paperresult 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 grangercausality test to determined effect the above said variables to stock price he found that interest rate isnot 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 sectorperformance in economy for the period 1997 to 2007. he used variables export and foreign exchangerate and foreign direct investment. He used methodology of granger causality test he finding are allvariables are significantly effect stock price. He found the data is not stationary which sign that there isspeculation in stock market he run AR which has high significance value

Fazal Hussain and Tariq Masood (2001) they used variable investment, GDP and consumptionand used granger casualty test to define the relation ship between these variables to stock price therefinding 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 pricesand 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 resultare insignificants which shows inefficiency in market final conclusion is that these economies areemerging 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 marketand the result of his analysis is significant. He found that fiscal and monetary policy change marketcapitalization through equity (changes floated shares) and liquidity which can significantly causalrelation 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 relationship 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 usedARDL model which used dynamics analysis. His finding are stock hedges against inflation in long runbut 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 1971to 2006.

Safail Sharma (2007) he used rate of interest, exchange rate, industrial production index, moneysupply and inflation as explanatory variables he used AR and MA as also explanatory variable toremove effects of non stationary in the data. His finding are lags values are highly correlated withcurrent prices suggest speculation in market. Exchange rate, industrial production index and moneysupply is significantly related he took data set 1986 to 2004.


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Song-zan-chiou-wei(2000) he used money supply oil price and exchange rate as explanatorilyvariables for Asian stock market he used VAR model applied to observed the differences of thestructure of fluctuation after 1997 financial crises. His finding oil prices and inflation are highly effectthe 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 relationwith stock prices he defines interest parity condition effect on stock prices his results showsunambiguous effects on deprecation of stock prices on exchange rate deprecation

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: stock prices relation ship regarding to

foreign exchange is suggest to be decreasing/ increasing due to liberalization of stock market inany economy foreign direct investment will increase valuation of return and prices are as

follows. psr =++= /

Where = is total gain which equal to price of share = net dividend / profit = capital gainr = real interest rate

= risk premiumps = price of sharesAs liberalized stock market it can cause reduced risk premium and increase competitionin stock market which increase stock prices. Due to increase inflow of foreign exchangecurrency its supply increases it can cause to appreciate local currency so price of shareincrease due to improve foreign exchange reserve it cause exchange rate appreciatewhile 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 causefalling stock prices and another reason for falling stock prices is that when increase in interestrate it can cause increase in cost of production it can detorate companies profit and dividendwhich can reduced prices of shares it may also argued that the effect of discount rate would benegated if cash flows increase in same rate as inflation. How ever cash flow go not up withinflation other economy suggest pre existing contract would deny any immediate adjustment forfirms revenue and cost

Stock market and money supply: the direction of impact of monetary growth is negativebecause increase money supply increase in inflation so people maintained there real cashbalance so they sells share and other assets which cause decline in share prices but on otherhand increase monetary growth reduce interest rate which reduce cost of capital and increaseearning of corporation. So we have found ambiguous effects.

Industrial production index and stock prices: the direction IIP and stock prices are positiverelation ship because increase IIP shows the increase in production of industrial sector whichincrease profit of industries and corporation. As dividend increase and share prices areincreases so positive relation is found between IIP and share price

Gross fixed capital formation and share price: gross fixed capital formation is defined as fixedassets accumulation. Assets accumulation increase by bond finance and equity finance if


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cooperation wants to finance assets they floats share so supply of share increase and declineshare prices or other ways increase assets finance by bond then firm/corporation creditworthiness decline which cause decline firm share prices so theory says increase Gross fixedcapital formation decline share price in short run but in long run production increase causeincrease share price so we can says ambiguous effects of share pricesWe 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 isthat 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 statisiticalsteps must be taken the step included descriptive statistics, unit root, and auto regressive integratedmoving average (ARIMA) model testing. The nature of time series data, it is necessary to teststationary of each individual variable. Stationary menas mean and variance between two time periodsdeapnd only on the distance or lag between the two time periods and not on the actual time at which covariance 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 ++++= 1t jt r at r r

we set the null hypothesis no stationary and alternative hypothesis is staionary and check all thevariables stationary by ARIMA to make them stationary. We have finally the model

+++++++= EXRR M GFCF IIP IR EXRSP 654321 2In the above equation is constant and is coefficient of variables while is normally

distributed error term

V. Result AnalysisThe empirical result or evidence provided by the various studies mentioned in the section of reviewliterature is shows that macroeconomics variables have strong effects on the stock market. In otherwords national stock market is said to be information ally inefficient with respect to mostmacroeconomics variables. If market is inefficient with respect to information then it has importantimplication both at micro and macro level. As evident in table no. 1

Table 1:

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 1.960819Jarque-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 we saw in above table no.1 it can shows that all the variables are positively skewed whichshows that they are asymmetrical. Kurtosis value of all variables also shows 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 or other word we can says no


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randomness in data and therefore, being sensitive to speculation shows periodic change. This indicatedthat 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. Thefunds 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 grossfixed capital formation other wise all variables are not stationary at level but they are stationary at firstdifference 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

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**significance level at 5%

Table 3: Dependent Variable: SP

Variable Coefficient Std. Error t-Statistic Prob.C 462.2149 729.6082 0.633511 0.5281

AR(2) 0.983048* 0.035285 27.85994 0.0000MA(1) 0.983110* 0.012342 79.65724 0.0000

Significance level at 5%

As evident from above table Karachi stock share prices are autoregressive of order 2 and highlysignificant 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 exchangeare also taken 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 0.0984EXR -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 as reported in table no. 4 foreign exchange rate is highly significance at4% level. It found that negative relation with KSE which shows that foreign institution investment hasbeen 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%


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significance level. IIP are also significance at 9% level which suggested that as industrial productionincrease stock prices are increase. Interest rate is negatively related to stock prices as interest rateincrease 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. ConclusionThe finding of this research paper is that the hypothesis suggests that the changes in themacroeconomics variables cannot be used as a trading rule by investors to earn consistently abnormalprofits in the stock market. Current as well as past information on the growth on the variables are fullyreflected in assets prices so that investors are unable to formulate some profitable trading rule using theavailable information.

The main objective of the present paper is to study the relationship between macroeconomicsvariables and Karachi stock market. We have used quarterly data of foreign exchange rate, foreignexchange reserve, gross fixed capital formation, M2, call money rate (interest rate proxy), Industrialproduction index and whole sales price index (proxy of inflation). The result shows that exchange rateand exchange reserve and highly affected the stock prices. We have saw that after liberalization in1991 of stock market in Pakistan has largely increase stock prices in Pakistan. The empirical result alsosuggests that IR and M2 is also significant and effect negatively to stock prices. However, fewvariables like IIP and GFCF are neglect able effects to stock prices so result suggested that increasecapital formation by firms and increase industrial production not affects stock prices.

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Impact of Macroeconomics Variables on Stock Prices Emperical Evidance in Case of Kse Karachi Stock Exchange