Capital Market Co-Integration of Pakistan and its Trading Partners: An Empirical Analysis

Abstract

In the ever-globalizing economy, the investors continuously look elsewhere outside their local markets to diversify their portfolios and to reduce risk. One of the main factors in such international diversification is the extent of integration of the capital markets, the extent to which there is a long-term relationship between the capital markets can restrict the potentials of diversifying investments across the international borders.

This paper empirically examines whether the stock market of Pakistan, the PSX-100 index, and the capital market of ten major trading partners of Pakistan, which include the United States, China, the United Kingdom, Germany, India, Hong Kong, South Korea, Japan, Malaysia, and Singapore, are long-run co-integrated. The study applies the strict econometric tools, the Augmented Dickey-Fuller test of stationarity and the Johansen co-integration test of relationships in the long-term equilibrium using daily stock index data between May 2014 and May 2024.

The results also display a very important discovery: there is no statistically significant co-integrating long-run relation between the Pakistani equity market and any of the ten trading partners of the country throughout the research period. This lack of a long-term stable relationship implies that this Pakistani market is independent of these major economies in the long run. Based on this result, the study offers solid evidence that, international investors can effectively diversify their risks by investing in Pakistani equities in their portfolios in addition to assets of these developed and emerging markets. These findings suggest to the portfolio managers and policymakers how the capital market of Pakistan has rare and potentially lucrative opportunities when it comes to global investment strategies.