Impact of exogenous variables (crude oil and gold) on stock returns volatility: A case of Karachi stock exchange

Usman Islam and Safia Nosheen

Abstract

The purpose of this study is to understand the impact of gold and oil prices on the volatility of Karachi stock exchange (currently Pakistan Stock Exchange)-returns. In recent years, gold and crude oil have suffered significant changes, and most of the economies have been affected due to this change. This study primarily explores how much volatility is caused in Karachi stock exchange returns due to fluctuations in oil and gold prices. This study uses augmented dickey fuller test to check the stationarity of variables and ARCH and GARCH models with lag 1 to find the relationship between variables. The results of this study reveal that oil prices and domestic inflation significantly affect the market returns volatility, whereas gold price has no significant effect on the volatility of Karachi stock exchange-returns. Pakistan’s market is a developing market; therefore it is not influenced by the Gold prices like other developed countries. This study uses 132 monthly observations for stock returns for a period ranging from 2005-2015. Oil is one of the largest imports of Pakistan and has a direct impact on Pakistan’s
economy. Therefore, results show a significant impact of oil prices in the volatility of Karachi stock exchange-returns.
Keywords: ARMA, ARCH, GARCH, oil prices, gold prices, volatility.