An Empirical relationship between Macroeconomic Indicators and Pakistan Stock Market: 1992-2012

The present study investigates the relationship between macroeconomic indicators and the performance of Pakistan's stock market proxied by KSECAP by estimating a linear regression model with OLS, ARDL Cointegration, and a Vector Error Correction Mechanism (VECM) techniques. This empirical study used monthly data from 1992M01 to 2012M12. The statistical results lead to the conclusion that macroeconomic indicators including inflation (CPI), money supply (M2), a nominal exchange rate of Pakistan's currency (Rupee) per US dollar (EXR), gross domestic savings (SAV), the gross domestic product (GDP) and a nominal interest rate (INT) at levels and at their respective lag values have a significant impact on the performance of Pakistan's Stock Market. Results also conclude that TAX has an insignificant impact on the performance of Pakistan's stock market. In addition, it is concluded from the results generated from the ARDL bound testing cointegration technique that the long-run equilibrium relationship does exist between macroeconomic indicators and the performance of Pakistan's stock market. Furthermore, a VECM also confirms that a long-run relationship does exist between macroeconomic indicators and the performance of Pakistan's stock market. At the same time, the estimated error correction term indicates that the speed of adjustment is 1.2830 percent to adjust back to a long-run equilibrium in case of any departure from it. The current empirical study has short-run as well as long-run implications, especially when policymakers are designing policies about the growth prospects of financial markets, when fund managers are making investment decisions to invest in the capital markets and also when project managers are formulating capital investment decisions in emerging economies like Pakistan's. In addition, implications are useful for retail investors looking for good returns on investments in capital markets such as stock markets.