An Empirical Analysis: A two-way causal relationship between Monetary Policy and Banking Stocks in Pakistan

Abstract

This study aims to analyze the relationship of stock market and monetary policy in Pakistan in view of the vital role of banks in an economy. The research is an attempt to explore the banking sector of Pakistan and study the implications, if any, of monetary policy shifts on the banking stocks in Pakistan. The data focuses on a sample of 14 banks, including all private, public, and specialized banks operating during the period of 2005 to 2011. It is proposed that a change in monetary policy variables tends to have a direct impact on the banking stocks in Pakistan. The study made use of statistical and econometric tools like Granger Causality and Panel data model to analyze the relationship between the variables, Monetary Policy and Stock Market, Regime/policy change impact, and Monthly effect on banking stock returns in the perspective of Pakistan. The study is unique in its way of being the first to have studied the monthly effect on returns of banking stocks in Pakistan. The findings reveal existence of a strong link of monetary policy and stock markets in Pakistan. It also shows that regime change did not have significant impact on individual stock returns. Yet months play an important role in determining the banking stock returns. Based on the findings the author proposes State Bank of Pakistan to adopt Expansionary monetary policy for the purpose of capacity building of financial institutions, so as to improve performance of all banks leading to a rise in their stock prices and market performance.