Causal relationship between macro-economic indicators and stock exchange prices in Pakistan

Abstract

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-economiccondition of the country. Key words: Macro-economic indicators, causality, exchange rate, index of industrial production, inflation, money supply, Pakistan.