Full Length Research Paper
Causal relationship between macro-economic indicators and stock exchange prices in Pakistan Imran Ali1, 2*, Kashif Ur Rehman1, Ayse Kucuk Yilmaz3, Muhammad Aslam Khan4 and Hasan Afzal5 IQRA University, Islamabad, Pakistan. COMSATS Institute of Information Technology Lahore, Pakistan. 3 Department of Aviation Management, School of Civil Aviation, Anadolu University, 26470 Eskisehir, Turkey. 4 Preston University, Islamabad Campus, Pakistan. 5 Independent Researcher, Hong Kong. 2 1
Accepted 17 December, 2009
Stock market plays an important role in the economic development of a country. A number of studies have been investigated on the causal relationship between macro-economic indicators and stock exchange prices. But in the context of Pakistan, not many studies can be traced in literature, moreover this study has used the set of macro-economic indicators which has not been previously used by researchers in Pakistan. It has examined the causal relationship between macro-economic indicators and stock market prices in Pakistan. The data from June 1990 to December 2008 have been used to analyze the causal relationship between various macro-economic variables and stock exchange prices. The set of macro-economic indicators includes; inflation, exchange rate, balances of trade and index of industrial production, whereas the stock exchange prices have been represented by the general price index of the Karachi Stock Exchange, which is the largest stock exchange in Pakistan. The statistical techniques used include unit root Augmented Dickey Fuller test, Johansen’s co-integration and Granger’s causality test. The study found co-integration between industrial production index and stock exchange prices. However, no causal relationship was found between macro-economic indicators and stock exchange prices in Pakistan. Which means performance of macro-economic indicators cannot be used to predict stock prices; moreover stock prices in Pakistan do not reflect the macro-economic condition of the country. Key words: Macro-economic indicators, causality, exchange rate, index of industrial production, inflation, money supply, Pakistan. INTRODUCTION Managing risks in the stock market is critical to financial sustainability in companies. Risk management is the process of measuring, or assessing risk and then developing strategies to manage the risk while attempting to maximize prices. For this reason, causal relationships between financial elements should be determined by holistic risk management practices. In the context of risk management, both macro and micro economic indicators should be considered by risk managers. Also, causal relationship between these indicators with market risk factors should be analyzed in the process of risk management. Risk management provide sound information about useful indicators to predict market risks which includes stock market variables, stock market-related information, stock prices, macro-economic performance in timely manner, etc. In unstable stock exchanges, both investors and market regulators need models for assessing, managing and minimizing risks. Market investors need risk management models to manage the risks associated with their open positions in the market. Market regulators on the contrary must guarantee the financial integrity of the stock markets and the clearing houses by suitable margining and risk containment systems (Varma, 1999).
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