THE CAUSAL RELATIONSHIP OF INTEREST RATE AND STOCK PRICES: EMPIRICAL EVIDENCE FROM PAKISTANI MARKETS

Abstract

This study is focusing on the relationship between stock returns of the Karachi Stock
Exchange (KSE) and the short term interest rates in Pakistan. The stock returns are
calculated from Karachi Stock Exchange 100 index, and monthly rates of six monthly Tbills
for the period of 1994 to 2014 are used for short term interest rates. . At first, we find
out the significant short term and long term relationships between stock returns and the
interest rates through the error correction mechanism and co-integration test. Then
Granger Casualty test is used to test that either the stock prices cause the interest rates
or the interest rates cause the stock returns. Thus we find no significant relation between
these two variables in either direction. So interest rate is not a Granger cause of stock
returns and stock returns are also not a Granger cause of interest rates in Pakistan.