Abstract
The purpose of this study is to examine the stock returns variation to specific macroeconomic and industry variables by applying multi-factor model. The firms of banking industry were selected for this study on the basis of data availability, profitability and performance on the Karachi Stock Exchange. The data for the selected firms and economic variables obtained for the period of 10 years. Descriptive statistics performed for the temporal properties and GARCH model was used to analyze the risk and return relationship. The tests were applied on the stock returns of each firm and on the data set of the entire industry to generalize the results. The results reveal that market return is largely accounts variation in stock returns, however the inclusion of other economic variables has added to the explanatory power of the model. It is also found that industry stock returns are more responsive to changes in economic conditions than firm level stock returns.
Highlights
There is a long history about the determinants of stock returns in the empirical capital market research literature
The descriptive statistics of macroeconomic variables indicate that ∆Consumer Price Index (CPI), ∆ExRate and ∆M2 variables are positively skewed, whereas ∆Karachi Stock Exchange (KSE), ∆Rate of Return (RFR) ∆Industrial Production Index (IPI) and ∆Banking Spread (BS) series are negatively skewed but all with higher than normal kurtosis i.e. these series are leptokurtic
The results of the study provide some insight about the relationship of economic factors and stock returns and the pattern of the behavior of stock returns at the firm and industry level
Summary
There is a long history about the determinants of stock returns in the empirical capital market research literature. In addition to the traditional equilibrium based model, a number of multi-factor asset pricing models have been developed. These models are based on the assumption that the stock returns are generated by a limited number of economic variables or factors (Opfer and Bessler, 2004). These factors include market return as well as other various factors, which are grouped into industry-wide factors and economic factors. Two theories are very important in explaining the stock returns variation, one is called Capital Asset Pricing Model (CAPM) and the other is known as Arbitrage Pricing Theory (APT). Theses models attempt to answer the questions whether the market return is the only factor that explains stock returns variations and the question is: what extra-market factors should be considered as likely candidates when investigating stock returns volatility?
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