An Analysis Of The Connectedness Between Pakistani,and Foreign Stock Markets

The increased trade and capital flow between economies have integrated the financial markets beyond the concept of Geography proximity.After the global financial crisis of 2008,the developments in stock markets have shown an increase in connectedness with each other.These changes in the connectedness level have also increased the stability and liquidity of stock markets.However,studies show that some of the markets have still not well integrated with others.In the light of recent studies on the stock market connectedness,we found novel and very significant research questions still unanswered for the stock markets like Pakistan.According to the best of our knowledge,this is the first study to answer the questions:Is the stock market of Pakistan,connected with its trading partners,and other foreign stock markets?What is the level of connectedness of the Pakistani stock market these stock markets?and What are the potential benefits/implications of the stock market connectedness?International trade and capital flow are important sources of linkage between the two economies.Therefore,we aim to study the long term relationship,and the connectedness level between the stock markets of Pakistan,its trading partners,and the other developed countries having trade and economic relationship with Pakistan.In order to achieve the objectives of the study,we used daily stock price indices for the sample countries.In the first phase,we selected the top trading partners to analyze the stock market connectedness.Among the trading partners,we selected China,Germany,Indonesia,UAE,and the USA.In the second phase,we selected the developed market from the(G-7)countries which are also the minor trading partners of Pakistan as the second sample.These countries include Canada,Italy,Japan,and the United Kingdom.We used Morgan Stanley capital international(MSCI)daily price data of the selected countries,from 2005 to 2018.In the first empirical part we used first-order models like cointegration test,vector error correction model(VECM),and Granger causality tests to determine long-run and short-run relationship between the stock markets of Pakistan,and the foreign stock markets for the trading partners(Sample 1),and the developed stock markets(Sample 2).In the second empirical part,we used daily price returns to determine the volatility,and the connectedness between the stock markets of Pakistan,and other countries.For both the samples,we divided the sample into three sub-sample to discuss in detail the differences in the results of three sub-periods.The sub-periods are:before the crisis period,during the crisis period,and the after crisis period.We utilized the Dynamic Conditional Correlation(DCC)Generalized Autoregressive Conditional Heteroscedasticity(GARCH)models with Gaussian,and student t-distribution to study time-varying correlation and volatilities of stock markets of Pakistan,and the global markets.The time-varying correlation has been used as a proxy of the connectedness level between the two countries.The results of the study show that the stock markets of Pakistan have long term relationships with its trading partners and the other developed stock markets which are maintained through short term changes in the stock prices of the selected stock markets.Further the results of the DCC-GARCH based study also show that the behavior of each market has changed with the GFC in 2008.Most of the markets had high volatility during the crisis period,later the stock markets moved towards low volatility.Especially the overall volatility of the Pakistani stock market has decreased after the crisis period.We found different behavior of the Pakistani stock market with its major trading partners and the developed economies.Pakistan shows more connectedness with its trading partners after the crisis period than the before crisis period.On the other side,the stock market connectedness has decreased with the developed markets(Minor trading partners)after the crisis period.This study concludes that the Pakistani stock market has more connectedness with its trading partners(especially the emerging markets)than the developed markets.However,the temporary innovations in the markets may change the connectedness in the opposite direction.Which means the stock market of Pakistan move in the same direction with its trading partners and move in the opposite direction with the developed economies having minor trade with Pakistan.The results have practical implications for policymakers of Pakistan.The higher level of connectedness of the stock markets brings significant economic benefits but it also exposes domestic financial markets to international financial changes as has been observed in the past few decades.The low level of stock market connectedness has benefits for the investors who want to diversify their portfolio.However,the policymakers should make policies for moving towards more connectedness,while avoiding the risk of contagion from other markets.The thesis is organized as follows:the second chapter discusses the concepts related to Stock market connectedness and the theories explaining the connectedness mechanism between the stock markets.Further in this chapter we also comprehensively organized the previous work on this topic from Empirical,theoretical and geographical perspectives.The third chapter is dedicated to the theoretical framework development and the hypothesis of the study.In the fourth chapter,we have analyzed the trade of Pakistan with selected countries with the help of graphs and tables.The fifth chapter applies cointegration,and VECM models to study the long term relationship between Pakistan and its trading partners.The sixth chapter presents the study on the stock market connectedness between Pakistan and its trading partners using the DCC-GARCH model.The last chapter is about the contributions of the study,the policy recommendations,and the future research".