Impact of Macro Economic Factors on Karachi Stock Exchange Group Members Hammad Ahmed Qureshi MM113101 Asad Ruman Khan Lodhi MM113088 Muhammad Ali Jinnah University Islamabad Introduction Since last three decades impact of market based factors on the stock price is very striking and appealing area for the researcher. The basic portfolio model was developed by Harry Markowitz (1952), who developed the measure for calculation of expected rate of return and expected risk measure. In 1964, William Sharpe added the risk free asset in Markowitz portfolio theory; this led to the base of Capital Market Theory. With addition of risk free asset the options for the investors were extended and a model to determine the risk premium was developed known as Capital Asset Pricing Model (CAPM). Stephen A. Ross (1976) subsequently devised an alternative asset pricing model that makes fewer assumptions than the CAPM and does not specifically require the designation of a market portfolio. Instead, the APT asserts that expected security returns are related in a linear fashion to a multiple common risk factors and these factors have orthogonal relationship. Chen, Roll, Ross (1986), Burnmeister and Wall (1986), Beenstock and Chan (1988), (Ahsan, Ahmed, Haq, & Sadia, 2007 ,(James N. Bodurtha, Cho, & Senbet, 1989),KAUL, (1987), Fama (1981) found relationship of macroeconomic variables and stoke market. Spyrou (2001), Mark (2001), Kazi, (2008),Ibrahim & Yusoff, (2001) examined the impact of inflation on equity market Money supply stated by (M1) it is used as a proxy of money supply in county increase in money supply lead to increase in liquidity that leads to upward movement of stock prices. It is hypothesizes that increase in money supply is positively related to stock prices. Consumer Price Index is used as a proxy for inflation rate. Change in price of good and service is used to calculate inflation rate in specific period. We used in this study US$/Rs exchange rate. It is hypothesized that depreciation in home currency is negatively related to equity prices. T-bills rates have been used as proxy of Interest rate. Increase in interest rate also leads to increase in discount rate and it ultimately results in decrease in present value of cash inflow and leads to decrease in prices. KSE is Pakistan largest and oldest stock exchange for the buying and selling of long term securities of companies 658 listed in it. The aim of study to analysis the relationship between interest rate, money supply, exchange rate and inflation on stock prices of 25 companies of different sectors from period 2005 to 2010 using monthly data of stock prices. Consumer price index used as proxy of inflation in this research. This data has been used first time in Pakistan to examine the impact of Interest Rate, Money Supply, Exchange Rate and Inflation on the prices of different companies list in Karachi Stock Exchange. This study shall be helpful for investors while making investment decision and adding securities in their portfolio in different economic conditions and for the monetary regulatory bodies while making monetary and fiscal policy. Literature Review The basic portfolio model was developed by Harry Markowitz (1952). In 1964, William Sharpe added the risk free asset in Markowitz portfolio theory. Ali1, Rehman1, Yilmaz, Khan4, & Afzal, (2010) Analysis relationship between macro- economic variables and stock prices and found no causal relationship between stock prices and macroeconomic variables. Ataullah, (2006) had examined the impact of exchange rate , inflation and oil price on stock prices and found that these are the source of systematic risk in Pakistan. Ahsan, Ahmed, Haq, & Sadia, (2007) Examined that economic and financial variables have significant relation with stock prices. Akmal, (2007) has examined the relationship between inflation and stock prices in long run as well as in short run using ARDL approach The results supports that stocks prices hedges against inflation in log run but not in short, on other hand in black economy stock prices are effected by inflation in long run as well short run. Atmadja, (2005) Observed the Granger-causalities between stock prices and macroeconomic variables in five ASEAN countries and found that different macroeconomic variables react differently in different countries, variables had significant effect in one country might be insignificant in other country. Butt & Rehman, (2010) had examined the impact of macroeconomic variables in emerging market and found that different industries respond differently in similar economic conditions. Burnmeister and Wall (1986) examined relationship between industrial production and stock return and find positive relationship. Beenstock and Chan (1988) examined relationship between and not found significant. Choi, Elyasiani, & J. Kopecky, (1992) Revealed that Exchange Rate is negatively related to Stock Returns.Calvio, Leiderman, & M,(1993) Analysis that changes in exchange rate leads to change in cash inflow of the companies which lead to change in share prices. Chen, Roll and Ross (1986) explore significant positive relation between industrial productions and stock market return. Fama (1981) found that inflation affect stock prices negatively. Olivier J,(1981) Examined that inflation caused change to interest rate and found that increase in inflation rate also increase interest rate and it leads to decrease in stock prices. Gan, Lee, Yong, & Zhang, (2006) has examined that Interest Rate and Money Supply have insignificant relation with stock prices. Gunasekaragea & Pisedtasalasaib, (2004) has examined a strong relationship between Rate of Inflation, Money Supply, T-Bill Rate, CPI, Exchange Rate and Stock Prices. Gunsel & Cukur, (2007) has examined both positive and negative correlation between macroeconomic factors and UK Stock Market. Hardouvelis, (1987) has examined that stock prices are consistent with real Interest Rate Hypothesis. Humpe & Macmillan, (2007) has examined the existence of negative relation between interest rate and Inflation with stock prices. Hassan & Nasir, (2008) had examined the relationship between macroeconomic variables and equity prices using historical data of stock prices from 1998-2008 by using ARDL approach. Ioannidis, Katrakilidis, & Lake, (2004) Found positive relation between inflation and stock return for the period of 1985-2003 in Greece. Izedonmi & Abdullahi,( 2011)Examined that macroeconomic factors exchange rate ,inflation ,market capitalization have no significant on stock return in Nigeria ,which also indicates that other macroeconomic factors effect stock return in Nigeria. Ibrahim & Yusoff, (2001) Examined positive relation between money supply and stock price in short run and negative effect in long run. James N. Bodurtha, Cho, & Senbet, (1989) examined that macroeconomic variables impact on stock prices and found significant relation in domestic and international perspective. Jiranyakul,( 2009) Examined the relationship between four economic factor and stock market return and found that industrial production and money supply affect stock market positively while inflation affect negatively stock returns. Kazi, (2008) Examined integration of Australian stock market with other market and found significant relationship. Kuwornu, (2011) had examined the relationship between macroeconomic variables and stock return and result showed a significant relationship between exchange rate, inflation rate and interest rate. Inflation has positive significant effect on stock prices and exchange rate and interest rate effect stock prices negatively. Result revealed that industrial production, oil prices and inflation had insignificant relationship whereas interest rate exchange rate and money supply had significant relationship in long run as well in short run. KAUL, (1987) analyzed that negative relationship between stock return and inflation caused demand and supply of money. López-Herrera & Ortiz, (2011) Analyzed impact of domestic macro factors and international market factors on stock prices and found that domestic economic factor effect more than international factors on stock prices. M. Adam & Tweneboah, (2009) had examined that Inflation Positively correlate’s with Share prices. Maysami, Howe, & Hamzah, (2004) has examined the significant negative relationship between Interest Rate, Exchange Rate, Money Supply and Singapore Stock Market. Menike,( 2006) has examined that there is significant negative relation exist between exchange rate, concurrent inflation rate and Treasury bill rate on Colombo Stock Exchange. Mark (2001) finds the mixed empirical evidence about relationship between equity market returns and inflation. Mark J & Protopapadakis, (2002) examined the influence of macroeconomic factor on stock prices using different models and found significant relationship. Maysami, (2004) examined the long run relationship between stock return and industrial production, inflation, exchange rate, interest rates and money supply. Nishat & Shaheen, (2004) has examined the significant relationship between CPI, M1 and Karachi Stock Market. Naka, Mukherjee, & Tufte, (1998) Examined that Inflation is the largest negative determinant for Indian Stock Market. Nsel, rsoy, & Rjoub,( 2009) has examined that significant relationship exist between stock returns and Macroeconomic Variable’s namely: Inflation, interest rate, Risk Premium and Money Supply. Paul and Mallik, (2001) analysis the long run relationship between macroeconomic variables and stock prices in Australia for the period 1980-1998 and explored that interest rate affect stock prices significant negatively and found no significant effect of inflation on stock prices. Spyrou (2001) also examined significant negative relationship between stock prices and equity return. Singh, Mehta, & Varsha, (2011) has examined that Exchange Rate Significantly affects Stocks returns. Türsoy, Günsel, & Rjoub, (2008)Analysis macroeconomic variable relation on turkey stock return ,result revealed that exchange rate , interest rate and world market return affect all of the portfolio ,while inflation affect only three portfolio return out of twelve. Visaltanachoti, Luo, & Kesayan, (2006) has examined about the insignificance of foreign exchange rate. W.J, Nung, & Chin W, (1998) examined that the due to change in Exchange Rate leads to Changes in Stock prices. Hypothesis Development: Exiting literature leads us to hypothesize as follows. Ho: There is no relationship between Interest rate and stock returns H1: There is relationship between Interest rate and stock prices Ho: There is no relationship between exchange rate and stock prices. H2: There is relationship between Exchange rate and stock prices Ho: There is no relationship between Money supply and stock prices H3: There is relationship between money supply and stock prices Methodology Litterateur suggest that relationship between stock price and macroeconomic variables in significant. Change in systematic variables brings change in stock prices. There are two types of factor which affect stock prices. One in systematic factors which affect whole economy and others are unsystematic factors which are company specific. There exist a relationship between the stock returns and systematic variables. Change to these variables brings change in the level of sensitivity of the stock returns, so stock prices are usually considered to be affected by these systematic variables, which are like external forces to the In this study we analysis systematic factor’s impact on the prices on company listed on KSE. All companies listed on KSE are population of this study. We use sample of 26 companies of different sectors as a sample for this research. Data Collection We use monthly data of stock prices for sampled companies collected from Karachi Stock Exchange website for five years: from 2004 to 2008. To facilitate the comparison convenient we convert data in returns taking natural log of ending price divided by beginning price. Data on independent variables Exchange Rate, Inflation (CPI), s and Money Supply (Narrow Money) is taken from the State Bank of Pakistan website for the period of 2004-2008. Exchange rate is taken as Pak Rupee against US Dollar. As these variables differ in denomination, we scaled the data by calculating the percentage change for ease in comparisons. Data Analysis Descriptive Statistics Table 1 Mean Std. Deviation N Price 73.0828 94.50954 1656 Cpi .0087 .00882 1656 M1 .0153 .02239 1656 X.Rate .0051 .01349 1656 Correlations Table 2 price cpi M1 X.Rate Pearson Correlation price 1.000 .051 -.008 .025 Cpi .051 1.000 -.176 .604 M1 -.008 -.176 1.000 .147 X.Rate .025 .604 .147 1.000 Sig. (1-tailed) price . .018 .374 .154 Cpi .018 . .000 .000 M1 .374 .000 . .000 X.Rate .154 .000 .000 . N price 1656 1656 1656 1656 Cpi 1656 1656 1656 1656 M1 1656 1656 1656 1656 X.Rate 1656 1656 1656 1656 Summary table 3 Change Statistics Mode Adjusted RR Square l R Square Square Change F Change Sig. F Change 1 .003 .001 .003 1.502 .212 Coefficients Table 4 Standardized Unstandardized Coefficients Coefficients 95.0% Confidence Interval for B Model B Std. Error Beta t Sig. Lower Bound Upper Bound 1 (Constant) 67.714 4.072 16.631 .000 59.728 75.699 cpi 631.951 351.032 .059 1.800 .072 -56.565 1320.466 M1 17.373 111.319 .004 .156 .876 -200.967 235.713 X.Rate -78.390 228.358 -.011 -.343 .731 -526.292 369.511 Table 3 show R square value is very low so independent vaiable has no significant impact on stock prices Result in table 4 show t values is less than 1.96 so there is no significant relationship exists between different macro economic variables and stock return. Implication. This study helps the investor in making decision about their portfolio in different sector in dynamic environment. it also help government for formulation of monetary policy and Imposing tax on different sector in economy. Future Research Direction This study provides base to analysis impact of macroeconomic factor on different sector of economy at wider range. In future Implication of CAPM and APT in developing countries and develop country can be tested. We analysis only macro variables lot of work can be done to investigate the impact of both macro and micro economic factors. Limitation This study has some limitations for example the convenience sampling technique may not be appropriate to generalize results. However if comparatively large sample is taken from each sector and more macro and micro variable both are taken together, the study can yield better results. We don’t have sufficient time to expand our research to wider range. Bibliography 1. Ross, S. A. (1976),”The arbitrage theory of capital assets”, Journal of Economic Theory, 341-360. 2. Olivier J, B. (1981). Output,Stock Market,and Interest Rate. American Economic Review, 71(1), 132-143. 3. Fama, E. F. 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