Impact of Macro Economic Factors on Karachi Stock Exchange by tahirnisarraja

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									Impact of Macro Economic Factors on Karachi
              Stock Exchange

                Group Members

          Hammad Ahmed Qureshi

           Asad Ruman Khan Lodhi

Muhammad Ali Jinnah University Islamabad
       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


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

                     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.


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.


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.

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