Short Run and Long Run Dynamics of Macroeconomics Variables and Stock Prices : Case Study of KSE (Karachi Stock Exchange)

The prime object of the study is to find the long run relationship between macroeconomic variables and prices of shares in Karachi stock exchange in Pakistan context. For this purpose the study considers the monthly data of several macroeconomic variables such as real foreign exchange rate, foreign exchange reserve, industrial production index, whole sale price index, gross fixed capital formation, and broad money M2 , these variables are obtain from 1987 to 2008 period. For the purpose of finding long run relationship among the variables Johansen co-integration test is applied. The results show that after the reforms in 1991 the influence of foreign exchanges rate and foreign exchange reserve effects significantly to stock market. The result also shows that there was positive relationship between GFCF and M2 while WPI is negative relationship with stock price. The result also highlighted that interest rate is insignificant with stock prices in the long run. The VECM analysis illustrated that the coefficients of ecm1 (–1), and ecm2 (–1) were significant with negative signs. The coefficients of both error correction terms showed high speed of adjustment. The results of variance decompositions revealed that out of seven macroeconomic variables inflation showed greater forecast error for KSE 100 Index