IMPACT OF MACROECONOMIC FACTORS ON STOCK

MARKET RETURNS OF KSE 30 INDEX

1. Abstract
The purpose of this study to examine the impact of macroeconomic variables (exchange rate,
inflation, interest rate) on stock market returns of KSE 30 index. Secondary data has been used in
this research. Data analysis technique that was used in this research are correlation, and
regression analysis. The study consists of data for the period of 10 years starting from June 2008
till June 2018. For this purpose, quarterly data of KSE-30 index has been observed. The results
revealed that interest rate and inflation has a significant impact on stock market returns, while
exchange rate has an insignificant impact on stock market returns. The current study is
considered the first of its kind conducted on KSE 30 index. To the best of our knowledge no
such studies have been conducted on KSE 30 index returns.
Keywords: Stock market returns, interest rate, inflation rate, exchange rate.

2. Introduction
The rapid growth in the equity market has fascinated investors as well as researchers, to study
the volatile behavior of stock market returns as a result of different macroeconomic factors.
Equity market is not only an avenue for the investors but also a source of capital for the firms.
The stock returns from equity market are highly influenced by multiple factors such as
performance of that particular stock, overall market conditions, prevailing economic conditions,
etc. The study of aforesaid variables is important enough to analyze the performance of the
stocks. In this regard, the causal relationship between macroeconomic factors and volatility in
stock market returns is the part of many researches. This type of studies enables the investors to
make effective and efficient investment decisions and also helps the firms to improve their
market worth.

In [ CITATION Nis05 \l 1033 ] Uses Vector Auto regression (VAR) to determine the impact of
macroeconomic variables on the stock returns of Bombay stock exchange (BSE) and revealed
that macroeconomic factors such as interest rate, gold price, exchange rate and money supply is
observed for the stock returns, additionally, a strong influence of the global macroeconomic
factor of the world price index is also observed, which implies a gradual integration of BSE
towards the global financial markets. In another study of [ CITATION Ali11 \l 1033 ] analyzed

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the impact of changes in selected microeconomic and macroeconomic variables on stock returns
at Dhaka Stock Exchange. From performing different test it was concluded that inflation and
foreign remittance have negative influence and industrial production index; market P/Es and
monthly percent average growth in market capitalization have positive influence on stock
returns. All the independent variables can jointly explain 44.48 percent variation in DSE all-
share price index.

Another study examine the macroeconomic variables and stock market returns a panel analysis
from selected ASEAN Countries, by utilizing the monthly data over the period of 2005 to 2015,
by applying the paned regression techniques and concluded that both stock market returns are
significantly affected by the ER and inflation rate. MS is found to be insignificant and inflation
poses a greater effect and inversely related to the stock market returns [ CITATION Mac17 \l
1033 ].

Balagobei (2017) also analyzed the macroeconomic variables and stock returns in Srilanka. This
study concluded that the stock market returns is influenced by macroeconomic variables except
money supply in Sri Lanka. Interest rate and factory industry production have negative influence
on stock market return in Colombo Stock exchange while inflation rate and exchange rate have
positive influence on stock market return. In [ CITATION Özl12 \l 1033 ] uses autoregressive
distributed lag method is employed for the data spanning from 2005 to 2012. And the result of
this research concluded that exchange rate and interest rate are the most significant factors in the
stock price fluctuations of the companies. Stock returns of the companies in any industry are
very sensitive to the changes in exchange rate and interest rate.
Many other researcher research on this relationship under different circumstances and different
time span. [ CITATION Kan08 \l 1033 ] Investigates the role of macroeconomic factors in explaining
Turkish stock returns. A macroeconomic factor model is employed for the period that spans from
July 1997 to June 2005. The macroeconomic factors used by him was growth rate of industrial
production index, change in consumer price index, growth rate of narrowly defined money
supply, change in exchange rate, interest rate, growth rate of international crude oil price and
return on the MSCI World Equity Index.

3. Literature Review
Stocks markets play very important role in the whole financial system in any country of the
world. There are only two sources of finance available for the firm, in which one is equity and
other one is debt. The financial institution provide the debt and equity financing is done at stock
markets. There are many factors that influences the prices and returns of stocks. D. Gay (2008)
explored the effects of macroeconomic variables on stock returns. Research was conducted in
emerging economies such as India, Brazil and Russia. From the results, there was a significant
relationship between the macroeconomic variables in the study and stock returns in Emerging

2
economies. Interest rates had a positive impact on stock returns in emerging economies stock
market.
Laichena and Obwogi (2015) explored the effects of macroeconomic variables on stock returns.
The researcher conducted the study in the east African community stock exchange market. From
the results, there was a significant relationship between the macroeconomic variables in the study
and stock returns in East Africa. The findings relating to interest rate revealed that increase in
interest rates had a negative impact on stock returns in East African stock market. This was an
important realization as it established the negative effects increase in interest rates have on stock
returns. The study also found that there was a positive significant relationship between inflation
rate and stock returns in East Africa stock market. Inflationary pressure, however, is associated
with increase in money supply hence increased investment levels. [ CITATION Kha18 \l 1033 ]
Explored the Impact of Macroeconomic Factors on Stock Returns. The researcher conducted the
study on the KSE 100 index. The results revealed that there was a positive impact of exchange
rate on stock return, while inflation rate and interest rate had a significant negative impact on
stock return. The results of variance decompositions revealed that out of three macroeconomic
variables Inflation rate showed greater forecast error for KSE 100 Index. The study shows that
the macroeconomic variables have a great influence on the stock returns. From the analysis we
concluded that all the companies of Karachi stock exchange will be affected by variation in
macroeconomic factors. The increase in macroeconomic factors may cause decrease in company
stock returns.

In Nisha (2016) Impact of Macroeconomic Variables on Stock Returns has been examined. The
study was conducted on the Dhaka stock exchange. From the empirical findings from the time
series and cross sectional analysis of this study imply that a time variation in the risk exposure
from the changes in domestic macroeconomic variables of India do not conforms timely to the
stock prices of DSE. In another research the Impact of selected macroeconomic variables
(inflation, exchange rate, and interest rate) was done on Karachi stock market returns. The results
of research indicated that indicated that the present inflation level does not have any effect on
market performance but rather it takes time for the market to react to changes in the inflation
rate. The results of exchange rate indicate that the investors of KSE market not care about the
exchange rate variation they prefer to invest in market rather than foreign currency. [ CITATION
Per18 \l 1033 ]
Ali (2011) studied the Impact of Micro and Macroeconomic Variables on Emerging Stock
Market Return. The research was conducted on Dhaka Stock Exchange (DSE). The study have
find that Inflation and foreign remittances are negatively related with stock prices indicating the
fact that additional funds flow through inflation and foreign remittances increase the supply side
through additional funds flow in the stock market while demand side remains unaffected. On the
other hand there is a positive relationship is found between stock price and the remaining
independent variables i.e. industrial production index, market price/earnings and monthly
average growth rate of market capitalization. [ CITATION Mac17 \l 1033 ] Analyze the

3
relationship between macroeconomic variables which are inflation, money supply, and exchange
rates on stock market returns. This research was conducted on the three selected ASEAN
countries, which include Singapore, Malaysia and Indonesia. The findings of the study indicates
that that both stock market returns of ASEAN countries are significantly affected by the
exchange rate and inflation rate. Money supply is found to be insignificant. This study also
suggest that both Islamic indices and conventional are affected by the macroeconomic variables
with identical pattern.
Singh, Mehta, and Varsha (2011) was also examined the relationship between Macroeconomic
factors and stock returns, which was conducted in Taiwan. They use money supply, inflation,
employment rate and exchange rate as a macroeconomic factor. This reveal the empirical
findings that exchange rate and GDP seem to affect all of the portfolio returns, except the PBR
portfolio of small companies. [ CITATION Kan08 \l 1033 ] Investigated the relationship between
macroeconomic variables, firm characteristics and stock returns. This study was conducted in
Turkey, and the data span in this study was July 1997 to June 2005. The results reveal that that
exchange rate, interest rate and world market return seem to affect all of the portfolio returns. On
the other hand, industrial production, money supply and oil prices do not appear to have
significant effects on stock returns. Inflation rate gives complex results.
The impact of macroeconomic variables on stock market returns in Kenya was analyzed by
[ CITATION Oum14 \l 1033 ] . Monthly data from 2003-2013 was used, and arbitrage pricing theory
(APT) and capital asset pricing model (CAPM) was applied. OLS reveal that there is a long run
impact of money supply on stock returns in Kenya postulate that an increase in money supply
causes stock market returns to increase. The results also reveal that there is a positive impact of
inflation (CPI) on stock market returns for the ten year period investigated, this imply that in
Kenya stocks cannot be used as a hedge against inflation. [ CITATION Kib14 \l 1033 ] Investigated
the impact of macroeconomic variables on stock market return. This research was carried out in
Pakistan. This study reveal that the inflation has positive and insignificant relationship with KSE
100 index. The results also that that the stock prices have Granger Cause with GDP savings, and
GDP per capita do not Granger Cause the stock returns.

3.1. Hypotheses of this study

H1: Inflation has a significant negative impact on stock market returns.
H2: Exchange rate has an insignificant impact on stock market returns.
H3: Interest rate has a significant positive impact on stock market returns.

3.2. Conceptual framework

INFLATION

4
 STOCK MARKET
EXCHANGE RATE
RETURNS

INTEREST RATE

4. Methodology
Data for the stock market returns was collected on the quarterly basis from Pakistan Stock
Exchange for the period of ten years from 2008 to 2018. The data on macroeconomic factors was
collected from the State Bank of Pakistan, and from the various other websites. Karachi Stock
Exchange-30 index has been used as a dependent variable in the study. Eviews 10 software is
used in this research to analyze the data.
4.1. Inflation
When purchasing power of money decrease or Real value of money decreases. Inflation
measured as consumer price index (CPI). The data for inflation rate was collected from the
website of state bank of Pakistan.
4.2. Exchange rate
The rate at which currency is exchanged with another currency. Exchange rate of Pakistani rupee
to the U.S dollar has been used. The data for exchange rate was collected from the website of
yahoo finance.
4.3. Interest Rate
The rate at which the lender receives money from the borrower for using his/her money. The six
months treasury bills rate has been used as a proxy for interest rates. The data for interest rate
was collected from the website of state bank of Pakistan.

The regression model for this study is presented as follows:

KSEit = β0 + β1INTit + βINFit + βERit + Ɛt

Where,
KSE = is the stock market returns of KSE 30 index,
β0 = is the constant

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β1INTit = is the slope coefficient of interest rate,
β2INFit = is the slope coefficient of inflation rate,
β3ERit = is the slope coefficient of exchange rate,
Ɛt = is the error term.

5. Empirical Results
In this section of research we accomplish the empirical to study the association between stock
market returns of KSE 30 index and macroeconomic factors which include interest rates,
inflation and exchange rate. The hypotheses is to study the impact of macroeconomic variables
on stock market returns. The test was run through the data and estimation were noted.

5.1. Correlation Analysis

Table 1: Correlation
Returns Interest Rate Exchange Rate CPI
Returns 1.00000
Interest 0.001111 1.000000
Exchange Rate 0.038094 -0.899723 1.000000
CPI -0.212619 0.883555 -0.840976 1.000000
CPI = Consumer Price Index. Returns = KSE-30 index returns

Table1 show the correlation analysis output. We found that there was a negative significant
relationship between stock return and inflation rate (rho = -0.213, p<0.05). In addition, the
exchange rate was found to have a significant positive relationship with stock returns (rho 0.038,
p<0.05). We found out that there was significant positive relationship between stock return and
interest rate (rho = 0.0011, p<0.05).
5.2. Regression Analysis
Table 3: Regression
Variable Coefficient Prob.
C -0.115642 0.8500
CPI -0.025810 0.0053
Exchange Rate -0.000429 0.9292
Interest Rate 4.037394 0.0476
R – Squared 0.208203
Adjusted R – Squared 0.140334
CPI = Consumer Price Index

The empirical result shows in table 5 that there is a significant relationship between inflation rate
(CPI) and stock market returns because its p-value is 0.0053 which is less than 0.05.The value of
its Inflation coefficient i-e −0.025810 tell us that there is negative relationship between inflation
and stock market returns which means that if 1% increase inflation rate will decrease stock
market returns by 2.581% and vice versa. There is an insignificant relationship between
exchange rate and stock market returns because its p-value is 0.9292 which is higher than

6
0.05.The value of its exchange rate coefficient i-e −0.0000429 tell us that there is negative
relationship between inflation and stock market returns which means that if 1% increase
exchange rate will decrease stock returns by 0.0429% and vice versa. And there is a significant
relationship between interest rate and stock market returns because its p-value is 0.0476 which is
less than 0.05.The value of its interest coefficient i-e 4.037394 tell us that there is positive
relationship between interest rate and stock market returns. It show that there is a direct
relationship between interest rate and stock market return. In table 5 regression analysis also
show that 14.03% changes cause by interest rate, inflation and exchange rate, and remaining due
to other factors.

6. Discussion, Conclusion and Recommendation

6.1. Discussion
The findings from the study showed that there was a significant relationship between
macroeconomic variables and KSE-30 index stock returns. In consideration of the first
independent variable, Inflation, the study found that there is a significant negative relationship
between inflation rate and stock returns. This means that increase in inflation resulted in decrease
in stock return. Earlier studies also confirmed the significant relationship between inflation and
stock return.
The study also found an insignificant relationship between exchange rate and stock return.
Therefore, an increase in exchange rate did not led to a decrease or increase in stock return.
The study also found a significant positive relationship between interest rate and stock return.
The implication was that increase in interest rate affected stock returns positively.
6.2. Conclusion
The stock markets play very essential role in the growth and development of the economy,
because efficient stock market engage the domestic and foreign investors. The performance of
the capital market is can be measured from the index which is effected by different factors such
as political social and macroeconomic. The purpose of this research is to empirical investigate
the impact of macroeconomic factors which include interest rate, inflation rate and exchange rate
on stock market returns of Karachi stock exchange 30 index. The quarterly data of ten year from
2008 to 2018 was used in the study. All the test i.e. descriptive statistics, correlation, and
regression analysis execute on quarterly basis. The results revealed that inflation and interest rate
has a significant impact on stock market returns, while exchange rate has an insignificant impact
on stock market returns of KSE 30 index. The study show that there is an impact of
macroeconomic factors on stock markets.
6.3. Recommendations
The Recommendation of this research paper is discussed below,
We have used Regression analysis method in this paper. Some other testing method like
Generalized Autoregressive conditional (GARCH), Multivariate co integration test or some other
model should be applied. We have taken only three macroeconomic variables like Inflation,
Interest and Exchange rate as independent variables, foreign direct investment, gross domestic

7
product, we can also take these variables. This research is limited to ten year time period from
2008 to 2018, someone can take longer period to get more accurate results. This paper is limited
to KSE 30 index. Use some other index so that the scope of research will be increase.

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