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LONG RUN RELATIONSHIP BETWEEN INFLATION AND STOCK RETURN: EVIDENCE FROM PAKISTAN

Keywords: Inflation , stock return , Cointegration , causality.

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Abstract:

This study is an important attempt to understand the complex process of inflation which become than just a problem all around the world and its impact on the money earn from the investment on stock returns. The objective of this research study is to investigate a long run relationship between KSE 100 index return and inflation rate in Pakistani economy. Quarterly data from January 1996 to December 2011 has been used. The study investigates whether change in inflation causes changes in stock returns and if so, in what direction. Augmented Dickey Fuller (ADF) unit root test has been used to find out the stationarity of the data at level or at first differences,Johansen Cointegration Technique has been used to determine the long term equilibrium relationship between inflation rate and stock prices. Finally Granger Causality Test has been used to find out the causal relationship between said variables. The evidence from cointegration test shows a negative relationship between KSE 100 index return and inflation rate because Pakistan is an under develop country when inflation occur it badly affect the economy which will ultimately affect the stock return and the reasons are economic condition and budget deficit along with some other factors and the Granger causality tests shows that there is no causality between KSE 100 index return and inflation rate in any direction.

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