Back Ground of the Problem:
The ideal stock exchange basically functions as a secondary market and supportsthe performance of primary markets. It also encourages investment in stock tradingby maintaining rules and regulations for investors’ protection that ensures trade willbe fair and investors will receiveexactly what they are paying for. The exchangealso supports state-of-the-art-technology and the business of brokering, which helpstraders in buying and selling their securities quickly and efficiently. The ideal stockexchange, thus, intends to perform the following functions for the economy:Raises capital for businesses: It helps in raising capital for running and expanding business by selling shares tothe investing public. Thus, the proper functioning of the stock exchange is integralto progression of productive business activities.Mobilizes savings for investment:It helps utilize resources by providing opportunities to investors of each level andmakes them invest their savings rather than keeping them in their bank accounts.This mobilization of resources promotes business activities and benefits differenteconomic sectors like textile, agriculture etc. Thus, economic growth is facilitated.Creates investment opportunities for small investors: For Pakistan, participation of small investors in investment activities is extremelyimportant since the sum of these small investments makes up a good percentage of total investment in the country. Thus, the stock exchange provides a platform forsmall investors too to play a role in the economy’s development.Government capital-raising for development projects:Governments can raise money for development projects by issuing bonds in thestock exchange like other companies. Thus, the stock exchange becomes animportant variable in the function of government expenditures for the developmentof the country.
Empirically, the performance of stock markets have been shown to positivelycorrelate with economic growth even after controlling for other factors associatedwith long-run economic growth such as initial conditions, size of government,inflation etc. Thus, for developing countries, the performance of the stock market isa vital indicator of the state of economic growth in the country. The ideal stockexchange’s performance enriches the confidence of domestic and foreign investorsdue to better economic growth, which then results in facilitating it even more asoverall investment increases due to higher confidence. This, as the reader will havefigured out from the above statement, results in a cycle of sustained economicgrowth as long as the stock market operates ideally.Lastly, an ideal stock exchange takes full advantage of the globalized state of theworld. Links among financial markets have enlarged and giant internationalfinancial players are showing their presence all over the world. This has resulted inthe importing of stock exchange activities abroad and now many international firmscross-list on international exchanges. The ideal stock exchange then makes use of state-of-the-art-technology to facilitate international trading of securities andincrease the confidence of foreign participators. The stock exchange, thus, becomesa platform for domestic investors to tap into larger economies too.Problem:
A high degree of volatility and uncertainty presest at Karachi Stock Exchange ishampering the Stock market to perform its functions. It is a well known fact thatstock exchanges all around the world are prone to the problem of market volatility.However, excessive volatility not only hinders the basic motive of investors, but alsoleads them to face severe market crisis such as the imposition of the floor.Unfortunately, Karachi Stock Exchange is the most speculative market in the worldwhen measured in terms of daily trading volume. This extreme volatility has led tothe drop in stock market such as in May 2008 by 19.78 percent which is the ‘worst’percentage loss for a single month since May 2000 when it dropped by 19.17percent. Moreover, when compared on global scale, Index volatility around activeglobal exchanges averages around 15 to 25% p.a. while comparative volatility forKarachi Stock Exchange is approximately 200 to 300% of global average in 2004and 2005. The massive volatile situation is possible due to the concentration of
trading by brokers in only a few stocks such as PPL, PSO, MCB, NBP and POL whichlimits the prospects of the exchange to grow on sound footings. Moreover thefluctuations in the prices of commodities in international market like oil, Politicalinstability in Pakistan and lack of derivative instruments for hedging are alsoconsidered as causes of market volatility.Because of such a high volatility of kse the market is losing confidence of investors,and kse is unable to perform its very functions for which it is created.FRAME WORK
Literature Review:1.Drimbetas, Evangelos, Sariannidis, Nikolaos and Porfiris,Nicos(2007) 'The effect of derivatives trading on volatility of the underlying asset: evidence from the Greek stock market', Applied Financial Economics, 17: 2, 139 — 148The study focuses on how the introduction of derivatives in the marketdecreases the volatility of the spot market. Derivatives giveinformation about the spot prices and moreover act as a hedginginstrument thus decreasing the speculative business. The articlesfocuses on empirical evidence from Greek stock market and usingdifferent statistical techniques show how volatility in the marketdecreases after the introduction of derivative instruments.2. Mustafa, Khalid. Testing of efficiency in emerging markets:a case study of karachi stock market.The article investigates the efficiency of Karachi stock exchange usingdifferent statistical techniques. This study has empirically investigated theefficiency of the Karachi stock market. The random walk hypothesis wastested on daily, weekly and monthly data from December 1991 to May 2003with three non-over-lapping periods and one combined period.
The empiricalresults indicated that the Karachi stock market was inefficient in all threetypes of data. This implies that the Karachi stock market did not follow therandom walk model. This lack of efficiency in the market is the prime causeof volatility since it implies that market prices does not represent the truepresent information and therefore much fluctuations can be expected infutute.
3.Uppal, Jamshed Y., and Inayat U. Mangla. "RegulatoryResponse to Market Volatility and Manipulation: A CaseStudy of Mumbai and Karachi Stock Exchanges." The LahoreJournal of Economics (2006). Print.
The study explains volatility in KSE and tries to compare it with India. Thestudy is very useful in understanding the causes of volatility in KSE and roleof Policy makers in this regard. The study focuses on how Indian becomesuccessful in curbing increase volatility in the stock exchange while PakistaniPolicy makers are unable to do so. The study also highlights that a strongercompetitive environment in India is very helpful for them to curb thevolatility and to control the increasing the increasing volatility. While inPakistan lack of competition in case of KSE is hampering the way forward forcurbing Volatility.4. S. Sergi, Bruno, Masood, Omar (2008),’ How political risksand events have influenced Pakistan's stock markets from1947 to the present’ International Journal of Economic Policyin Emerging Economies, Volume 1,pg427-444The study highlights the role of political instability on the stock market of Pakistan. The articles comes to conclusion the political instability is the muchembedded in the business of Pakistan that it carries a risk premium of 7.5%to 12%. The article also claims that such type of political instability willremain unchanged in the coming periods.5. Roe, Mark J. and Siegel, Jordan I., Political Instability: ItsEffects on Financial Development, Its Roots in the Severityof Economic Inequality (July 24, 2009). Available at SSRN:
Page Cannot be Found article focuses on how political instability impedes financial growth andresult in poor performance of the financial institutions. The study shows that
since 1960s when the data is properly gathered and recorded there exist avery important relationship between political instability and financialbackwardness.Definitions of the Terms:Volatility A statistical measure of the dispersion of returns fora given security or market index. Volatility can eitherbe measured by using the standard deviation orvariance between returns from that same security ormarket index. Commonly, the higher the volatility,the riskier the security.Efficient Market Efficient market is one where the market price isan unbiased estimate of the true value of theinvestment. Market efficiency does not require thatthe market price be equal to true value at everypoint in time. All it requires is that errors in themarket price be unbiased, i.e., that prices can begreater than or less than true value, as long as thesedeviations are random
Derivatives A financialinstrument whose characteristics and value dependupon the characteristics and value of an underlinginstrument, typically a commodity, bond, equity orcurrency. Examples of derivativesinclude futures and options.Stock Broker A stock broker or stockbroker is a regulatedprofessional broker who buys and sells shares andother securities through market makers or AgencyOnly Firms on behalf of investors Political Instability:
Stock market reflects the political stability of the country. It is evident thatduring incidents of emergency, assassination of Bhutto and judgesreinstatement issue the marked depicted a sudden downturn, while anypositive news has positive impact on the market like re-election of PresidentMusharraf, lifting of emergency, transparent election of 08 etc.The effect of political situation may cause the index to go up or it may causethe index to go down. Since political situation in Pakistan is very lesspredictable therefore the KSE index shows continuous ups and downs from2007 to 2008. These continuous ups and downs result in the increasevolatility of the KSE.PPl, MCB, NBP, and POL stocks as market movers:The KSE 100 index is moved by very few stocks which are traded in bigvolumes in the marked. Therefore if anything goes wrong with these stocksthe whole index goes down. We in our analysis tries to explain the that theperformance of KSE index is basically indicated by four stocks PPL, MCB,
NBP, POL. The KSE 100 index is regressed on these stock in order tounderstand is there any relation between these stocks and Index andmoreover are these stocks control the performance of index.Regression of KSE on PPL:Source | SS df MS Number of obs = 6-------------+------------------------------ F( 1, 4) = 58.34Model | .537275573 1 .537275573 Prob > F = 0.0016Residual | .036835564 4 .009208891 R-squared = 0.9358-------------+------------------------------ Adj R-squared = 0.9198Total | .574111138 5 .114822228 Root MSE = .09596------------------------------------------------------------------------------lkse | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------lppl | 1.015731 .1329793 7.64 0.002 .6465216 1.384941_cons | 3.736436 .7000249 5.34 0.006 1.792855 5.680016The results show that if there is beta is 1.015 showing that if there is onepercent change in the stock price of PPL then the KSE index will move onepercent. This is very important relationship because it shows that bothstocks move in almost identical direction. Moreover since R- squared is alsovery high number it means that much of the change in KSE index isexplained by PPL stock. Now in order to test significance of beta one can seethat beta lies between the confidence interval of Beta. Therefore the PPLstock price and KSE 100 index are very much related.
The above graph shows the percentage change in PPL on x-axis andpercentage change in KSE 100 index on y-axis. As the percentage change inPPL increase the percentage change in KSE also increases.Regression KSE on MCB:Source | SS df MS Number of obs = 10-------------+------------------------------ F( 1, 8) = 78.27Model | 6.22899993 1 6.22899993 Prob > F = 0.0000Residual | .636704279 8 .079588035 R-squared = 0.9073-------------+------------------------------ Adj R-squared = 0.8957Total | 6.86570421 9 .762856023 Root MSE = .28211------------------------------------------------------------------------------lkse | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------lmcb | .7927614 .0896102 8.85 0.000 .58612 .9994028_cons | 5.015169 .4003516 12.53 0.000 4.091956 5.938381In this case our Beta comes out to be .79. this means that if there is onepercentage change in the price of MCB there is .79 percentage change in theprice of KSE 100 index. Moreover in order to check the significance of Betawe can see that Beta lies between 95 % confidence interval.The graph above also shows that how as the percentage change in PPLprices on x-axis change correspondingly the KSE index on Y-axis alsochanges in the same direction.
Regression KSE on PSO:The regression of KSE 100 index on PSO is done then . Following results of our regression came out.Source | SS df MS Number of obs = 10-------------+------------------------------ F( 1, 8) = 45.61Model | 5.84110009 1 5.84110009 Prob > F = 0.0001Residual | 1.02460412 8 .128075515 R-squared = 0.8508-------------+------------------------------ Adj R-squared = 0.8321Total | 6.86570421 9 .762856023 Root MSE = .35788------------------------------------------------------------------------------lkse | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------lpso | 1.916013 .2837162 6.75 0.000 1.261762 2.570264_cons | -2.085763 1.566846 -1.33 0.220 -5.698916 1.52739Again a very high value of Beta came out that shows one percent change inprices of PSO stock result in 1.9 percent change in KSE stock. Moreover ourbeta is also within 95% confidence interval.The high Value of R-square shows that much of changes in percentagechange in KSE is depicted by PSO, which means that PSO is very importantstock of KSE 100 index and it is strong enough to move the direction of whole index.Also looking at the graph of percentage change in KSE and PSO it is clearthat both moves in the same direction. When PSO stock price goes up, KSEindex also goes up.
Regression KSE on NBP:Then KSE is regressed on NBP in order to show how NBP is important toestimate the KSE index.Source | SS df MS Number of obs = 8-------------+------------------------------ F( 1, 6) = 47.53Model | 2.67814222 1 2.67814222 Prob > F = 0.0005Residual | .338042635 6 .056340439 R-squared = 0.8879-------------+------------------------------ Adj R-squared = 0.8692Total | 3.01618486 7 .430883551 Root MSE = .23736------------------------------------------------------------------------------lkse | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------lnbp | .713353 .103466 6.89 0.000 .4601807 .9665252_cons | 5.609799 .466985 12.01 0.000 4.467128 6.75247Again the beta came out to be .7133 showing that one percent change inprice of MCB results in .713 percent change in the price of KSE 100 index.Again the R-square came out to be very high showing that much of thedeviation in the KSE index is explained by MCB stock.The graph shows that as the percentage change in MCB stock change theKSE index changes simultaneously.Role of Brokers:
“Brokers mostly act as principals and not as intermediaries (this has led to)...extremely high turnover ... extensive speculation ... (and) ...very little genuineinvestment activity, (with) hardly any capital raised .....To restore investor confidence: (i) stock exchange management should be freed from broker influence .... and (ii) government must support and be visibly seen to be supportingthe SECP's reform agenda.” 1The brokers in the Karachi Stock Exchange mostly traded as principals rather thanintermediaries. They trade between clients of same brokers or collude with otherbrokers to manipulate the market. The March 2005 crisis resulted from brokerstrading between themselves to first increase the level of index so that outsideinvestors could be attracted to the market and then they exited the market leavingoutside investors to trade themselves. The graph below mentions the tradingbetween 8 brokers who trade between themselves to manipulate the market.Further on, the ways brokers manipulate has been highlighted in more detail.1 Khawaja, Azim A., and Atif Mian. "Unchecked intermediaries: Price manipulation in an emerging stock marketstar, open."Journal of Financial Economics. Science Direct, 2005. Web.
Broker A: Moosani Securities; Broker B: Akeel Karim Dhedhi Securities; Broker C: Worldwide Securities; Broker D:A.H.K.D Securities; Broker E: Mr. Munir Ahmed Khanani; Broker F: Motiwala Securities; Broker G: Mr. MuhammadAnas Kapadia.Arif Habib is big broker at KSE, here we want to see the profits of Arif Habibas the deviation of the KSE 100 index. Since standard deviation of KSE indexis good indicator of market volatility we want to see is there any relation withthe profits of brokers and market volatility.The above graph depicts that the movement of standard deviation of KSEindex which is an indicator of Volatility and resulting change in Profit of Oneof very important securities firm Arif Habib.During the crash of 2005 and high volatility during this year the profit of Arif habib securities firm show a continuous increase. This shows the conflict of interest between principal and agent. Since securities firm act as agent whileinvestors act as principal, during 2005 of increase volatility many investorslost a lot money but the agent (Arif Habib) still keep on making money duringthese years. The calculations of the above graph is attached in appendix.Lack of Derivatives
erivatives are very important instruments for a market.Pakistan’s financialmarket has never been very efficient and lack of information regarding stock priceshas been at root of many problems in the past. Research on Greek stock marketfurnishes evidence that the introduction of derivatives induces a reduction involatility of the index and increases its efficiency by facilitating informationgeneration and evaluation. A study conducted by Fazal Husain and Tariq Mehmoodnotes that Pakistan Stock Market can not be declared as leading indicator of economic activity , therefore, derivative market in Pakistan has lot to add to theinformation and assessment of the market.
Above graph shows four year daily volatility profile of KSE 100 index. The graphshows high degree of volatility in 2002 and in 2005. Such a high degree of volatilitywill lead to manipulation of market and losses for real investors. One of the primereasons of such a high volatility is lack of hedging opportunities available inPakistani exchanges. With introduction of wider range of derivative marketproducts, reinforced with strong investment banking mechanism, investors will bebetter able to mange their risk by hedging, thus ensure a more stable financialmarket.International commodities price:In order to understand the impact of various regional and international factors likeincrease in the prices in the oil market we regress the percentage change in theKSE on the Bombay stock market.Source | SS df MS Number of obs = 10-------------+------------------------------ F( 1, 8) = 22.78Model | 5.08121123 1 5.08121123 Prob > F = 0.0014
Residual | 1.78449298 8 .223061622 R-squared = 0.7401-------------+------------------------------ Adj R-squared = 0.7076Total | 6.86570421 9 .762856023 Root MSE = .47229------------------------------------------------------------------------------lkse | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+----------------------------------------------------------------lindia | 1.20955 .2534268 4.77 0.001 .6251465 1.793953_cons | -2.203676 2.240916 -0.98 0.354 -7.371237 2.963885Since beta lies between 95% confidence interval this means that it is significant,now interpreting the results of our regression we can say that one percent changein Indian stock market results in 1.2 percentage change in KSE. But R-square is notlarge enough which shows that there are some other factors which are not includedin the model that explains the percentage change in KSE. But this is clear that thereis significant amount of change in KSE that explained by some external factors thateffect both BSE and KSE.The graph shows the movement of KSE and BSE. Both stock exchange show somesimilarity in their movement because of external factors.Conclusion:There is very high volatility of KSE and different factors that causes thisvolatility is explained. KSE index depends a lot on very few stocks andtherefore the sudden movements in prices of these stocks results in highvolatility. Moreover Political instability, lack of derivatives instrument, conflictof interest between broker and investor and International factors all result inhigh volatility of index.
AppendixFig 1.Date PPl MCB PSO NBPJuly,2000 28.1 173July,2001 21 124.1July,2002 24.05 138.5 21.25
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I think above will give you better understanding about Karachi stock exchange - it is not beating any market
1. it is highly volailtile due to very few stocks and it not a mature stock exchange
lol
at charts and say.... oh this is better.
