Abstract:
The stock market is a barometer of a country’s economy. The stock market of
Pakistan was initiated in the year 1947 at Karachi. Later on two more stock
exchanges were established in Lahore and Islamabad in the year 1970 and 1992
respectively. The intent of this study was to explore long run and short run
relationships between four stock indices i.e. KSE100 index, General index,
LSE25 index, and ISE10 index relating three stock exchanges namely Karachi
stock exchange, Lahore stock exchange, and Islamabad stock exchange in
Pakistan and five macroeconomic variables i.e. consumer price index, industrial
production index, real effective exchange rate, money supply, and three months
treasury bills rate. In order to investigate the long run and short run relationships
Johansen cointegation technique and VECM was applied. The study used
monthly data from November 1991 to June 2008 for analyzing KSE100 index and
General index, while from December 2002 to June 2008 and from July 2004 to
June 2008 for LSE25 index and ISE10 index respectively. The results showed
that industrial production has long run positive impact on stock returns in all three
markets. Exchange rate was positively affecting all indices except ISE10.Inflation
was positively related with stock returns at Karachi Stock market, while it was
negatively related with rest of the two markets. Increase in money supply had
negative impact on the stock returns, while treasurery bills rate had mixed effect.
The VECM analysis depicted that it takes more than four months for the
adjustment of disequilibrium of the previous period in case of KSE100 index. In
case of General index, nine months were required for disequilibrium adjustment.
The disequilibrium in LSE25 index required five months for adjustment, while
ISE10 showed the most speedy adjustment i.e. two months. The results of
Innovation accounting revealed that macro economic variables explained more
variance of forecast error incase of KSE100 index and LSe25 index than General
index and ISE10.
