This paper investigates linkages between the exchange rate, stocks and interest rate markets in Pakistan using the post-1999 data. The reform process, especially in the financial sector, accelerated in the post-1999 period, when the new military government assumed power in October 1999. In particular, fast privatisation of the banking sector was widely commended in international circles. In addition, a substantial increase in the foreign reserves led to a relatively stable exchange rate. Furthermore, low inflation provided stability in the interest rate market. Although we observed low volatility in all three markets (namely, the exchange rate, stock, and interest rate markets), it is interesting to analyse if these markets are integrated, and if so, whether stability in one market will lead to some positive impact on the other markets. This is the main objective of this paper. We use data on exchange rates, stock prices, and interest rates, and use Granger causality, variance decomposition, and impulse responses in a VAR model to determine if the three markets are interlinked. The results suggest that the markets have some weak linkages but do not support a long-run causal relationship.
|Number of pages||11|
|Journal||Pakistan Development Review|
|Publication status||Published - 1 Dec 2006|