Abstract

Foreign direct investment (FDI) is a mechanism of international flow of capital. It is not merely a conduit for transfer of money to an investment destination where it generates higher returns but also a channel for transfer of best practices including improved and innovative technologies, technical know-how, management methods, labor skills and other innovative practices of conducting business operations. This happens because of the ownership stake of the investing organization in its affiliate firm which gives investors some extent of authority in the management of its affiliate. Extensive amount of literature dealt with factors determining FDI flow into an economy and how it influences economic growth. Owing to conflicting evidence by various researchers the topic is still controversial. It started attracting more attention since capital control liberalizing policies by developing countries increased their growth in recent past. Relatively fewer studies deal with the issue of how FDI creates an influence on a country’s stock market, and no such study has been conducted in Pakistan. It is important to study how stock markets respond to FDI because stock markets give an estimate of investors’ trust and economic activity. This study examined this particular relationship by analyzing data using cointegration and Granger causality techniques.

Key words: Foreign direct investment, stock market, cointegration, granger causality.