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Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
Suliaman D. Mohammad Associate professor, Federal Urdu University of Arts, Science and Technology E-mail: suliaman1959@gmail.com Adnan Hussain Visiting Lecturer, Federal Urdu University of Arts, Science and Technology E-mail: adnanaerc@gmail.com Adnan Ali Student of M.Phil, Applied Economics Research Centre, University of Karachi E-mail: adnanaliabbasi@hotmail.com Abstract The object this paper is to find the relationship between macroeconomic variables and prices of shares in Karachi stock exchange in Pakistan context. We considers the quarterly data of several economic variables such as foreign exchange rate, foreign exchange 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 . We try 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 that after the reforms in 1991 the influence of foreign exchange rate and reserve effects significantly to stock market whiles other variables like IIP and GFCF are not effects significantly to stock prices. so our result shows that internal factors of firms like increase production and capital formation not effects significantly while external factors like exchange rate and reserve are effects significantly the stock prices. So the after post reforms period is positively effects stock prices. The study will be very help full for national policy makers, researchers and corporate managers etc.
I. Introduction
The stock market is supposed to play an important role in the economy in the sense that it mobilizes domestic resources and channels them to productive investments. However, to perform this role it must have significant relationship with the economy. Capital markets are key elements of a modern, marketbased economic system as they serve as the channel for flow of long term financial resources from the savers of capital to the borrowers of capital. Efficient capital markets are hence essential for economic growth and prosperity. With growing globalization of economies, the international capital markets are also 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 efcient market hypothesis suggests that competition among the prot-maximizing investors
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
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in an efcient market will ensure that all the relevant information currently known about changes in macroeconomic variables are fully reected in current stock prices, so that investors will not be able to earn abnormal prot 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 returns consistently, except through access to and employing insider information, a practice generally prohibited and punishable by law, there should be no stock broking industry, if one were to believe the conclusions of the EMH. Stock market is a critical cog in the wheel that smoothens the transfer of funds for economic growth. Broadly speaking, stock exchanges are expected to accelerate economic growth by increasing liquidity of financial assets and making global risk diversification easier for investors promoting wiser investment decisions. In principle, a well functioning stock market may help the economic growth and development process in an economy through growth of savings, efficient allocation of investment resources and alluring of foreign port folio investment. The stock market encourages saving by providing households having invest able funds, an additional financial instrument, which meets their risk preferences land liquidity needs better, it in fact provides individuals with relatively liquid means for risk sharing in investment projects. (agrawalla 2006).
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markets but due to current global financial crisis it can be declined to 9,000 because foreign capital out flows increase very sharply. As of Sept25, 2009, 654 companies were listed with a market capitalization 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 in section 4 we define some variables which used in study and define data set. In section 5 we define econometrics methodology which we used in study in section 5 we concluded result form this study and finally in section 6 we concluded our study report
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
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Song-zan-chiou-wei(2000) he used money supply oil price and exchange rate as explanatorily variables for Asian stock market he used VAR model applied to observed the differences of the structure of fluctuation after 1997 financial crises. His finding oil prices and inflation are highly effect the 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 relation with stock prices he defines interest parity condition effect on stock prices his results shows unambiguous effects on deprecation of stock prices on exchange rate deprecation
Where = is total gain which equal to price of share = net dividend / profit = capital gain r = real interest rate = risk premium ps = price of shares As liberalized stock market it can cause reduced risk premium and increase competition in stock market which increase stock prices. Due to increase inflow of foreign exchange currency its supply increases it can cause to appreciate local currency so price of share increase due to improve foreign exchange reserve it cause exchange rate appreciate while 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 cause falling stock prices and another reason for falling stock prices is that when increase in interest rate it can cause increase in cost of production it can detorate companies profit and dividend which can reduced prices of shares it may also argued that the effect of discount rate would be negated if cash flows increase in same rate as inflation. How ever cash flow go not up with inflation other economy suggest pre existing contract would deny any immediate adjustment for firms revenue and cost Stock market and money supply: the direction of impact of monetary growth is negative because increase money supply increase in inflation so people maintained there real cash balance so they sells share and other assets which cause decline in share prices but on other hand increase monetary growth reduce interest rate which reduce cost of capital and increase earning of corporation. So we have found ambiguous effects. Industrial production index and stock prices: the direction IIP and stock prices are positive relation ship because increase IIP shows the increase in production of industrial sector which increase profit of industries and corporation. As dividend increase and share prices are increases so positive relation is found between IIP and share price Gross fixed capital formation and share price: gross fixed capital formation is defined as fixed assets 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 decline share prices or other ways increase assets finance by bond then firm/corporation credit worthiness decline which cause decline firm share prices so theory says increase Gross fixed capital formation decline share price in short run but in long run production increase cause increase share price so we can says ambiguous effects of share prices We 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 is that 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 statisitical steps must be taken the step included descriptive statistics, unit root, and auto regressive integrated moving average (ARIMA) model testing. The nature of time series data, it is necessary to test stationary of each individual variable. Stationary menas mean and variance between two time periods deapnd only on the distance or lag between the two time periods and not on the actual time at which co variance 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 r = + rt j + at + rt 1 + we set the null hypothesis no stationary and alternative hypothesis is staionary and check all the variables stationary by ARIMA to make them stationary. We have finally the model SP = + 1 EXR + 2 IR + 3 IIP + 4 GFCF + 5 M 2 + 6 EXRR + In the above equation is constant and is coefficient of variables while is normally distributed error term
V. Result Analysis
The empirical result or evidence provided by the various studies mentioned in the section of review literature is shows that macroeconomics variables have strong effects on the stock market. In other words national stock market is said to be information ally inefficient with respect to most macroeconomics variables. If market is inefficient with respect to information then it has important implication both at micro and macro level. As evident in table no. 1
Table 1:
SP 127.6368 103.56 299.21 34.57 78.14981 0.972571 2.73852 14.12381 0.000857 88 EXCRES 3553.989 1322 14435 213 4217.17 1.163066 2.669788 20.23975 0.00004 88 EXR 39.89068 39.765 64.15 15.98 16.81541 0.019702 1.386929 9.546355 0.008453 88 GFCF 110574.6 89578.5 396551 17259 88349.3 1.241375 4.173968 27.65491 0.000001 88 IIP 105.5122 92.29 232 52.52 43.29091 1.104169 3.264533 18.13803 0.000115 88 IR 8.030114 7.89 15.42 1.05 3.050957 0.175299 2.924647 0.471524 0.789969 88 M2 400084.3 395424 1043700 69875.9 280527.7 0.411707 2.089966 5.522628 0.063209 88 WPI 81.3842 84.305 164.25 27.94 38.89997 0.274529 1.960819 5.064995 0.07946 88
mean median maximum minimum Std. Dev. Skewness Kurtosis Jarque-Bera probablity observation
As we saw in above table no.1 it can shows that all the variables are positively skewed which shows that they are asymmetrical. Kurtosis value of all variables also shows data is not normally distributed because values of kurtosis are deviated from 3. So the descriptive statistics shows that the values are not normally distributed about its mean and variance or other word we can says no
Impact of Macroeconomics Variables on Stock Prices: Emperical Evidance in Case of KSE (Karachi Stock Exchange)
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randomness in data and therefore, being sensitive to speculation shows periodic change. This indicated that 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. The funds 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 gross fixed capital formation other wise all variables are not stationary at level but they are stationary at first difference 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
At level -1.426297 3.311289 -1.335140 -1.647429 1.797305 -1.621632 -0.978078 -0.250161 At first difference -3.923520* -5.618675* -4.189409* -9.058792* -13.81579* -4.723153* -6.420688* -4.120358*
Variables Share price Gross fixed capital formation Foreign exchange reserve Interest rate Industrial index of production Whole sale price index (wpi) M2 (Broad Money) Foreign Exchange rate *significance level at 5%
Table 3:
Dependent Variable: SP
Coefficient 462.2149 0.983048* 0.983110* Std. Error 729.6082 0.035285 0.012342 t-Statistic 0.633511 27.85994 79.65724 Prob. 0.5281 0.0000 0.0000
As evident from above table Karachi stock share prices are autoregressive of order 2 and highly significant 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 exchange are also taken as independent variables.
Table 4: Dependent Variable: SP
Coefficient 50.93326 0.004599** -2.645900* -0.000134 0.151023** -1.242176* -3.59E-05* 2.411239* 0.820881* 0.989783* Std. Error 47.72902 0.002749 1.125605 9.09E-05 0.086775 0.595195 1.86E-05 0.813718 0.075523 0.001822 t-Statistic 1.067134 1.673216 -2.156000 -1.471965 1.740394 -2.087007 -1.931914 2.963239 10.86930 543.0924 Prob. 0.2893 0.0984 0.0356 0.1452 0.0858 0.0402 0.0571 0.0041 0.0000 0.0000
Variable C EXCRES EXR GFCF IIP IR M2 WPI AR(2) MA(1) *significance level at 5% **significance level at 10%
Further analysis also as reported in table no. 4 foreign exchange rate is highly significance at 4% level. It found that negative relation with KSE which shows that foreign institution investment has been 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 production increase stock prices are increase. Interest rate is negatively related to stock prices as interest rate increase 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. Conclusion
The finding of this research paper is that the hypothesis suggests that the changes in the macroeconomics variables cannot be used as a trading rule by investors to earn consistently abnormal profits in the stock market. Current as well as past information on the growth on the variables are fully reflected in assets prices so that investors are unable to formulate some profitable trading rule using the available information. The main objective of the present paper is to study the relationship between macroeconomics variables and Karachi stock market. We have used quarterly data of foreign exchange rate, foreign exchange reserve, gross fixed capital formation, M2, call money rate (interest rate proxy), Industrial production index and whole sales price index (proxy of inflation). The result shows that exchange rate and exchange reserve and highly affected the stock prices. We have saw that after liberalization in 1991 of stock market in Pakistan has largely increase stock prices in Pakistan. The empirical result also suggests that IR and M2 is also significant and effect negatively to stock prices. However, few variables like IIP and GFCF are neglect able effects to stock prices so result suggested that increase capital formation by firms and increase industrial production not affects stock prices.
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