Effects of Macroeconomic Variables on the Stock Market Volatility: The Pakistan Experience

Abstract

This research paper empirically investigates the effects of interest rates, exchange rates and inflation rates on stock market performance of Pakistan by using annual time series data covering the 1991-2017 periods. The prime intention of this research was to inspect the long-run and short-run relationships between the KSE-100 index and macroeconomic variables by employing the econometric techniques of Autoregressive Distributed Lag (ARDL) bounds testing procedure to cointegration and the Error Correction Model (ECM), respectively. By applying the ARDL model, the empirical results revealed the fact that there was a negative and significant impact of interest rate on the market index, whereas; the exchange rate and the inflation rate have a positive impact on stock market volatility in the long-run. Furthermore, the ECM analysis pointed out that an estimated coefficient of the error correction term was significant with expected negative sign and showed that 46.53% deviation of the stock market index are corrected in the short-run per year. The study recommended that the monetary authorities should further reduce the bank rate up to the lowest rate in order to stimulate the stock market performance, which in turn; will boost the existing investment level and will encourage the new investment into the stock market. In addition, this policy will also ensure in the reduction of higher inflation rates. And the study found that the reduction in bank rate and stabilization in exchange rate is essential to local and foreign investors in the short-run.