Impact of interest rate and exchange rate changes on stock excess returns : a comparison of Karachi stock exchange & Bombay stock exchange

Abstract

The Prime objective of this study was to ascertain the nature of relationship between interest rate & excess returns and exchange rate & excess returns. And how those changes in excess returns adjust in long run and short run time periods. To analyse this impact two markets were selected from neighbouring countries i.e. Karachi Stock Exchange, Pakistan and Bombay Stock Exchange, India. Data sample period was from 2001 to 2013. Companies which came out existent in this period through Survivorship Bias were selected. Based on �������������������������������� ���������������������������� ���������������������������� ���������������� �������������������� �������������������������������� ���������������� incorporated such as Interest Rate change and Exchange Rate changes, and estimation equations were generated. Partial Adjustment model was used to see the short run and long run adjustments in stock excess returns. During the period under study, world had been effected by a major financial crises and to see that effects on both markets, generated models were also run on segregated time periods. Results suggested that mostly in short run markets were aggressive and adjusted to changes in long run rather smoothly. And Indian Market was more aggressive than Pakistani. Overall Pakistani market preferred risk free rate over value factor. Both markets showed that a change in interest rate will effect the excess returns inversely. While factor loading of exchange rate changes indicated that in Pakistani market any change in exchange rate will decrease excess return but this was not true for Indian market. Segregated study of two market suggested that both markets were defensive before financial crises. This work suggest there was some impact of changes in variables on excess returns. But these results comes with its inherent limitations of lagged variables and there are more robust models exist which gives lead to future researches.