GARCH Risk Assessment of Inflation and Industrial Production Factors on Pakistan Stocks

Abstract

The purpose of the study was to measure the risk the return relationship of inflation and industrial production as macroeconomic variables against stock returns. The study extends the literature by using the GARCH model instead of the traditional Arbitrage Pricing Theory or the Capital Asset Pricing Model. The sample consisted of 50 companies listed on the Karachi Stock Exchange (KSE) in Pakistan. The data collection encompassed the period from July 1998 to December 2008. The macro economic indicators were inflation rate and growth rate of industrial production. The techniques included regression and first order Augmented Dick Fuller test (since it was a time series). The authors found a significant relationship between the macro economic indicators of inflation and industrial production against the sampled KSE returns. The sensitivity coefficients of industrial production and inflation were negative which indicated real sector risk and inflation unfavorably impacted the sampled KSE returns.