Abstract

This study is based on examining the relationship between stock exchange market volatility and macroeconomic variables volatility with respect to Pakistan. To measure this time series relationship for Pakistan exponential generalized autoregressive conditional heteroskedasticity (EGARCH) and lag-augmented vector autoregression (LA-VAR) models were used. It was found that there is a positive relationship of consumer price index (CPI) and foreign direct investment (FDI) with stock market; however, exchange rate (ER) and T-bill rate (TBR) are inversely related to stock market volatility. On the other hand, we found strong evidence that there is a bilateral relationship of FDI and ER with stock prices, while a unidirectional relationship was found between TBR and stock market prices, with the direction from stock prices to treasury bills interest rate. However, a significant causal relationship not found between CPI and stock prices. The analysis of this study reveals that the stock market of Pakistan is relatively less efficient as compared to US and other developed economies of the world.

Key words: Pakistan, macroeconomic volatility, stock market volatility, exponential generalized autoregressive conditional heteroskedasticity (EGARCH), lag-augmented vector autoregression (LA-VAR) model.