Impact of Political Instability on Pakistan Stock Market
Info: 2955 words (12 pages) Example Literature Review
Published: 6th Dec 2019
The topic of my research is Impact of political instability on the performance of stock market of Pakistan. To my opinion, political instability is a situation where by a country is currently going through political turmoil. It may also involve the death of people within that country, change of regimes and nature of the government. And as a result of political instability, in many cases the country deteriorates in terms of its economic progress. I would be highlighting the impact of major political instability incidents over the recent past in Pakistan and its impact on the Pakistani Stock Market. This means that my research is focused on the performance of stock market with relation to the political forces and how investors react to those forces.
Leblang & Mukherjee(2005) said that the causal logic underlying the central claim in democratic politics and financial markets literature-that the value of financial assets decrease but becomes increasingly volatile under left-wing governments is rooted in extant research on the effects of partisanship on the economy (e.g., Alt and Crystal 1983; Hibbs 1987). Herron (2000) argued that since traders anticipate higher (lower) inflation under a left-wing (right-wing) incumbent party, they rationally expect a decline (increase) in the real returns of stocks when the left (right) party wins elections and assumes office. Exante expectations of lower (higher) stock returns increases (decreases) uncertainty about the possibility of a stock market revival in the future, which leads to higher (lower) stock market volatility. A cursory view of the data revealed that the assumption of partisan- ship having discernible effects on inflation in the causal story described above is accurate. A difference in means test for inflation rates by presidential administration for the United States between 1900 and 2000 indicates that inflation is statistically higher during democratic administrations (p = 0.00). This result holds even if we drop the years when Jimmy Carter held the Presidency.They obtain similar results showing inflation being higher under Labor as compared to Conservative governments in Britain between 1940 and 2000 (p = 0.00). While the assumption linking partisanship to inflation are borne out the bulk of the partisan politics and financial markets literature rests on two faulty assumptions. First, existing studies ignore that if traders anticipate stock returns to decline under a Democratic (Labor) government, then they have a rational incentive to reduce their volume of trading. If the volume of trading declines, then stock price volatility will decrease since it is well known from empirical studies in financial economics that a decline in trading volume leads to lower market volatility (Gallant, Rossi, and Tauchen 1992). Second, if traders expect higher stock returns under a right-wing administration, then trading volume and capital inflows into the market increases rapidly, which leads to higher stock price volatility (Kothari and Shanken 1992).
Beaulieu & Cosset(2006) said that the short run effect of the 30 October 1995 Quebec referendum on the common stock returns of Quebec firms. Their results showed that the uncertainty surrounding the referendum outcome had an impact on stock returns of Quebec firms. They also found that the effect of the referendum varied with the political risk exposure of Quebec firms, that is, the structure of assets and principally the degree of foreign involvement. Their results indicated that the short-run effect of the referendum results on stock returns is positive and statistically significant for all four portfolios. This evidence suggests that the outcome of the 1995 referendum was not predictable. Yet, as discussed in Brown, Harlow, and Ticnic (1988), their results were consistent with the unexpected information hypothesis. That is, they can attribute the referendum results to the resolution of the uncertainty over Quebec political future. Furthermore, the fact that Quebec would remain within the Canadian federation probably was good news to financial markets, given the positive reaction of financial markets to the referendum outcome. If the referendum outcome had been negatively interpreted, there would probably have been no reaction, given the large decrease in market level when it became clear that the referendum outcome could not be anticipated. This further suggests that investors might have associated the NO vote in the 1995 referendum with a reduction in economic and political instability, although this cannot be directly inferred from their results. Nonetheless, their results clearly 640 M.-C. Beaulieu, J.-C. Cosset, and N. Essaddam reveal that political uncertainty can affect short-run stock returns of Quebec and Canadian firms when the uncertainty cannot be anticipated by financial markets. They also noted that the effect of the uncertainty about the referendum on portfolio returns is larger for firms most exposed to political risk than for firms less exposed to political risk. The impact of uncertainty resolution is less important for multi- national firms than for domestic firms. However, this result does not appear to be statistically significant for growth option characterizations.
G.KAUL H. SEYHUN (1990) talked about the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence showed that the negative stock return- inflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability. This paper investigated the effects of relative price variability on output and stock returns and gauged the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence showed that the negative relations between stock returns and expected and unexpected inflation proxy for the negative effects of relative price variability on the stock market. However, the adverse effects of relative price variability on output and the stock market are largely a reflection of the supply shocks witnessed in the seventies. The OPEC oil crisis of 1973-1974, in particular, appears to have had a major detrimental effect on output and the stock market. Nevertheless, controlling for the effects of future output growth does not attenuate the effect of relative price variability on stock returns. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link suggested by Fama (1981) and the supply shocks reflected in relative price variability particularly in the seventies
F. Renshaw(1967) explained that the adjustment process which is implicit in portfolio theory and show how this process enriches our understanding of financial instability. When the model is applied to debit balances held with brokerage firms belonging to the NYSE we can show that the stock market panics of 1962 and 1966 cannot be blamed on increased speculation and are forced to conclude that these declines were the result of poor management on the part of institutional investors. About 80 percent of the year to year percentage variation in debit balances belonging to customers of the New York Stock Exchange can be explained by variations in the annual returns-price appreciation plus dividends expressed as a percent of price at the beginning of the year-associated with S & P’s composite stock index during the 12 year period from the end of 1953 through 1965.Only ten of 26 declines of ten percent or more which occurred in S & P’s monthly price index before World War II were less than 24 percent. Since World War II there have been nine declines of ten percent or more and none of these persisted long enough to register more than 23.3 percent on a monthly basis. This difference does indicate a more stable stock market which ought to provide a foundation for greater courage in the wake of declining stock prices. As more investors begin to perceive that stock market panics have provided an opportunity to make a handsome profit with very little risk, we ought to achieve an equilibrium condition in the stock market that can better withstand shocks and be considered self-stabilizing.
GL Kaminsky & Schmukler (1999)said that the chaotic financial environment of Asia in 1997-1998, daily changes in stock prices of about 10 percent became commonplace. This paper analyzed what type of news moves the markets in those days of market jitters. They found that movements are triggered by local and neighbor country news, with news about agreements with international organizations and credit rating agencies having the most weight. However, some of those large changes cannot be explained by any apparent substantial news, but seem to be driven by herd-instincts of the market itself. The evidence suggested that investors over-react to bad news. While the instantaneous reactions to bad news are stronger than those to good news, our event-study analysis indicates that the one-day market rallies are sustained- and trend-changing while news or rumors that trigger market panics do not have persistent erects. These results suggested a recurring pattern of asymmetric response of investors to good and bad news that should be explained by the diriment theories of herding behavior and contagion in particular, and more in general by theories of investors behavior. Interestingly, the pattern during market rallies is consistent with investors following momentum trading, buying previous winners.
Perotti (2001) investigated whether privatization in emerging economies had a significant indirect effect on local stock market development through the resolution of political risk.They argued that a sustained privatization program represented a major political test which gradually resolves uncertainty over political commitment to a market-oriented policy as well as to regulatory and private property rights. The analysis further showed that changes in political risk in general tend to have a strong effect on local stock market development and excess returns in emerging economies, suggesting that political risk is a priced factor. In my view these observations and the results in the paper point to a strong potential for research developments in the area of political economy and corporate finance. Privatization, just as nationalization, has strong redistributive effects and tends to cause political conflict, whose outcome is most informative for investors.
RE Lane(1983) said that people develop their cognitive abilities and styles from their daily life experiences. Market tasks develop cognition characterized by frequent, personality significant, cybernetically informed, socially discussed, direct experiences more often regarded as rewarding than punishing. In contrast, political tasks often demand, but cannot effectively teach, abstract, personally remote, cybernetically less-informed cognitions required for effective citizenship. Market cognition tends to dominate political cognition because of its vividness and personal consequences, but the cognition taught by the market is often inappropriate for political tasks.
Further this article spoke that markets and politics each offer opportunities for complex thought, transcending routine, stimulus-bound, iconic patterns. And they both permit a minimal level of functioning with a minimal level of cognitive complexity. The difference is that the market has sanctions for low levels of performance while politics does not. The market’s contingency forms of rewards, its uses of profits as a stimulus to thought, reliance on 478 Lane price rather than rule information, on private goods rather than public goods, its lack of claims due to some ascriptive condition (personhood), its efficiency criteria-all contribute to this result.
The market like a school where “it is indeed a fact that massive general transfer can be achieved by appropriate learning, even to the degree that learning properly under optimum conditions leads one to ‘learn how to learn’ “? (Bruner, 1963). Or does market learning suffer from what has come to be called the Einstellung effect, “the blinding effects of habit… when a habit ‘ceases to be a tool discriminately applied but becomes a procrustean bed to which the situation must conform; when, in a word, instead of the individual mastering the habit, the habit masters the individual’?” (Luchins and Luchins, 1968). Viewed globally and historically, perhaps market cognition can be said to do both, and, perhaps sequentially. The market helped to make us more intelligent, but not intelligent enough for true democratic politics in a complex age. The market was the nurse, but like any good nurse, it should prepare its nurslings to do more than the nurse can do, to “master the habit,” to generalize not the contents of learning but the skills involved in previous learning.
S.Mishkin(1999) talked about the global financial instability and gives an overview about the events and issues related to the instability by giving practical examples of Mexico and East Asian markets. Two of the key questions facing policymakers today are how to reduce the risk of global financial stability, and how to cope with it when it occurs. This paper starts by defining financial instability and then showing how it harms economic activity. It then used this framework to describe what happened during the recent financial crises in Mexico and east Asia. The argument presented here suggested that although the fundamental underlying cause of financial instability is the presence of a government safety net with inadequate supervision of banking institutions, one mechanism through which the problem of instability becomes manifest is a vicious pendulum of capital inflows which lead to a lending boom and excessive risk-taking on the part of banks, followed by capital outflows. The dangers from capital flows thus raise the question of whether these flows should be regulated or limited in some way. Sebastian Edwards’s paper examines this question and discusses the evidence on whether capital controls can be effective.
Naceur& Ghazouani(2006) said that over the last four decades, a wide theoretical debate is concerned with the fundamental relationship between financial development and economic growth. Recent studies shed some light on the simultaneous effect of banks and financial system development on growth rather than a separate impact. The empirical study is conducted using an unbalanced panel data from 11 MENA region countries. Econometric issues will be based on estimation of a dynamic panel model with GMM estimators. Thus, peculiarities of MENA
region countries will be detected. The empirical results reinforced the idea of no significant relationship between banking and stock market development, and growth. The association between bank development and economic growth is even negative after controlling for stock market development. This lack of relationship must be linked to underdeveloped financial systems in the MENA region that hamper economic growth. Then, more needs to be done to reinforce the institutional environment and improve the functioning of the banking sector in the MENA region. Based on these results, other regions at the same stage of financial
development such as Africa, Eastern Europe or Latin America should improve the functioning of their financial system in order to prevent their economies from the negative impact of a shaky financial market.
Asteriou $ Siriopoulos(2003) examined empirically the relationship between stock
market development, political instability and economic growth in Greece. They measured socio-political instability by constructing an index which captures the occurrence of various phenomena of political violence using time-series data. The main advantages of analysing
political instability in a case study framework using time-series, in contrast with the widely used cross-country empirical studies, were: (a) a more careful and in-depth examination of institutional and historical characteristics of a particular country; (b) the use of a data set comprised of the most appropriate and highest quality measures; and (c) a more detailed exposition of the dynamic evolution of the economy. The empirical results indicated the existence of a strong negative relationship between uncertain socio-political conditions and the general index of the Athens Stock Exchange (ASE) and support the theoretical hypothesis that uncertain socio-political conditions affect economic growth negatively, is true for the Greek case.
Stock market performance
Bomb blasts and killings
American presence in northern areas
Duration of democracy
FDI and foreign AID
Leftist/ Rightist govt.
Musharraf period (historic)
Amendments in Law
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