Effects of Interest Rate and Exchange Rate on the Stock Market Performance of Pakistan: A Cointegration Approach

Waqar Khalid^1,

¹School of Economics, Quaid-I-Azam University, Islamabad, Pakistan

Cite this paper:
Waqar Khalid. Effects of Interest Rate and Exchange Rate on the Stock Market Performance of Pakistan: A Cointegration Approach. Journal of Finance and Economics. 2017; 5(5):219-232. doi: 10.12691/jfe-5-5-4

Abstract

This research paper is an endeavor to empirically investigate the economic effects of interest rates and exchange rates on stock market capitalization by considering annual data for Pakistan covering the 1990-2017 periods. The main intention of this research is to analyze the short-run together with the long-run interconnections between the aggregate market capitalization and macroeconomic variables by employing the econometric tools of Johansen approach, Error Correction Model (ECM) and then inspection of Variance Decomposition. And finally, causal linkages have been explored by the application of Granger-Causality test. By applying the Johansen Jeselius approach, it is detected that the whole series of data are co-integrated showing the long-term relationships among the examined variables. The long-term coefficient shows that a 1% increase in interest rate and in exchange rate contributes 0.23% decrease and 3.17% increase in market capitalization, respectively. The estimated ECM lagged value illustrates that in the short period, 22.07% volatility of market capitalization are corrected per annum to reach at the steady-state. And the analysis of Granger-causality tool reports the existence of a unidirectional causality from foreign exchange rate to interest rate. The further reduction of bank rate in the economy has been recommended in this study to facilitate the financial sector development as well as to stimulate the investment level both nationally and internationally.

Keywords:
interest rate exchange rate market capitalization short-run long-run johansen approach error correction granger causality stock market Pakistan

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