The Behaviour of Stock Returns in an Emerging Market: A Case Study of Pakistan

Abstract

In developed market economies, the stock market is a major conduit of financial resources from surplus units to deficit units. This transfer of funds is mutually advantageous to both parties. The recipients of these funds, publicly owned companies, are enabled to utilise them in profitable investments, while the surplus units, ultimately households, are provided an opportunity in sharing in the future profits of these enterprises. More importantly, by providing an active market for existing corporate securities, the stock market is also able to fulfil the liquidity needs of surplus units. The most significant academic developments in finance in the past twentyfive years have been portfolio theory, capital market theory, and efficient market theory, collectively called modem finance theory. These modem developments, based on the pioneering works of Markowitz (1959) and Sharpe (1964), and accumulating empirical evidence suggest that financial investors are well advised to make their decisions assuming that security prices fully and instantaneously reflect all publicly available information. This proposition is often referred to as the random walk hypothesis, which implies that successive security prices/returns are not statistically associated.