Abstract:
The main objective of this thesis is to explore the impact of monetary variables on
risk-return relationship using daily data from July 2004 to July 2014. Least Squares technique
is applied to test the interactive affect of all variables on risk-return relationship and the
results of economic model proved that there is insignificant negative effect of interest rate,
exchange rate, and interest rate on risk-return relationship. On the contrary, small size has
relatively little impact on risk and return relationship than medium size of the firm.
Subsequently, large size of the firm has shown highly positive impact on the relationship of
risk and return compared to small and medium size. However, the robust tests are also carried
out to counter check the results of economic model. Primarily, Vector Autoregression tests
are applied to test the effects of monetary variables on prices of the stock and Granger
Causality estimates are employed to examine the causal association among the variables. The
overall statistical estimates of Granger Causality indicate that there is causal association
between stock prices and exchange rates; stock prices and market capitalization. On the
contrary, there is no causal association between stock prices and interest rate; stock prices
and risk. The Vector Autoregression estimates showed fairly substantial results proving that
the relationship among all underlying variables is positive. However, the statistical estimates
have indicated that the risk-return relationship is negatively affected by contraction in the
monetary policy. The statistical estimates of exchange rates have shown significant positive
results throughout the research and it can be said that risk-return relationship improves with
the improvement in exchange rate and the results support the theory of Sharpe-Litner (1964-
65). The market capitalization has also indicated significantly positive results throughout the
thesis and a judgment can be made that risk-return relationship improves with the increase in
the size of the firm. Thus, all the monetary variables employed in this thesis except for
interest rate significantly affect the risk-return relationship.
