Dynamics of price clustering in the Pakistan stock exchange

Abstract

PurposeIn this paper, the authors study the phenomenon of price clustering in the Pakistan Stock Exchange (PSX), a market viewed as one of the best-performing stock markets in the world during 2014–2017. The authors study the effect of stock-level variables on price clustering and analyze the determinants of the cross-sectional patterns of price clustering in the PSX, in particular the causal link between price clustering and political instability.Design/methodology/approachThe authors' dataset comprises daily observations on 100 PSX stocks spanning from January 1, 2009 to June 30, 2019. The authors use multivariate regression and spectral analysis to shed light on the dynamics of stock price clustering in PSX.FindingsThe authors document abnormally high levels of stock price clustering, particularly on integer increments, in PSX. The nature of stock price clustering in PSX is consistent with the negotiation hypothesis of Harris (1991). The levels of stock price clustering on PSX are persistent and contain a cyclical component. Furthermore, the authors find that political uncertainty in Pakistan is a significant contributor to the high levels of price clustering on PSX. The authors' conclusions are robust to alternative econometric specifications and different measures of price clustering and political uncertainty.Practical implicationsThe authors' findings are of interest to investors and policymakers. Since price clustering decreases market quality and degrades the information content of stock prices, the authors' study shows that price efficiency in PSX has not improved despite major reforms over the last decade. One practical implication of the authors' results is that investors should be cautious while rebalancing portfolios around political events such as general elections because stock price clustering increases in the PSX during these periods. As a result, stock prices are likely to deviate from their intrinsic values.Originality/valueResearch on price clustering is limited to developed markets, and emerging/frontier markets have been largely overlooked. The phenomenon of price clustering in the PSX has yet to be studied, despite the relevance of the PSX for emerging/frontier market investors.