Stock Market Volatility Due to Economic Policy Uncertainty in Pakistan

Abstract

This study investigates the impact of economic policy uncertainty (EPU) on stock market volatility in Pakistan, spanning the period from 2008 to 2024. The research employs the Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model to measure time-varying volatility and correlates it with key policy events, including budget announcements, interest rate changes by the State Bank of Pakistan (SBP), tax reforms, and foreign direct investment (FDI), Government Spending (GS) trends. Data was collected from monthly stock returns of the KSE-100 index, simulated EPU data of Historic Events from 2008 to 2024 , and major policy announcements to identify patterns of volatility clustering and their triggers. The findings highlight a strong relationship between economic policy uncertainty and market volatility. Events such as fiscal policy adjustments of Tax reforms, exchange rate devaluations, and abrupt changes in monetary policy for interest rates changes caused significant spikes in market instability. Budget announcements were identified as a recurring driver of uncertainty, often resulting in heightened investor risk aversion. Similarly, SBP’s monetary tightening policies contributed to periods of elevated volatility. The analysis also underscores the critical role of FDI, with surges linked to CPEC initiatives for government spending temporarily stabilizing the market, while geopolitical tensions amplified vulnerabilities. This research provides actionable recommendations to mitigate volatility, including enhancing transparency in policymaking, maintaining consistent fiscal and monetary policies, and fostering improved communication with investors. By addressing EPU, Pakistan can reduce market uncertainty, encourage investment, and ensure sustainable economic growth. The study concludes with a call for future research on sector-specific impacts of policy uncertainty and its long-term implications for financial markets.