Dynamic Interplay between Monetary Indicators and Equity Market Valuation: An Empirical Study of Interest Rate and Exchange Rate Effects on Stock Prices in Pakistan

Abstract

This study investigates the short-term and long-term relationships between stock market performance, interest rates, and exchange rates in Pakistan, utilizing monthly data spanning from 2010 to 2023. Employing a robust econometric framework, including the Augmented Dickey-Fuller (ADF) test and the Johansen-Juselius cointegration method, the analysis confirms that all variables are integrated of order one and co-integrated, indicating a stable long-run equilibrium relationship among the variables. The long-run findings reveal that interest rates have a negative impact on stock market performance, while exchange rates exert a positive influence. In the short run, empirical results suggest that a 1% increase in interest rates leads to a 0.52% decline in stock market performance, whereas a 1% rise in exchange rates results in a 3.24% increase in stock market performance. The model demonstrates strong explanatory power, with an F-statistic of 266.62 (p < 0.05) and an R-squared value of 0.70, indicating that the combined effect of interest and exchange rate movements explains 70% of the variation in stock market performance. The coefficients of both variables are statistically significant, underlining their critical roles in influencing the dynamics of Pakistan’s stock market.