The stock volatility and contagion effect: Study from Pakistan

Abstract

The notion of efficient market hypothesis has dominated the financial markets for an extended time which explicitly states the prices of the securities
reflect all levels of information available. This fact was pursued by many of the rational investors, but in response to the global market crash, the concept
of behavioral finance emerged, and the patterns changed. In a decision-making process, a relational, financial decision-maker must consider not only returns
but also the variance and volatility of returns. The primary feature of this study examines the sentiments approach and random walk theory effects on the
Pakistan stock market, in addition to this, forecast the volatility of Pakistan stock exchange index by using past index values, whether such noise traders
are present in the Pakistan stock exchange. Furthermore, investigates the effect of the market index contagion factor, risk, return and volatility effect on
Pakistan stock exchange using the Generalized Autoregressive Conditional Heteroscedasticity estimation models. These results propose that market index
and volatility have an impact and an essential role in determining the dynamics on the stock returns.
In this study, quantitative methods have been adopted to investigate the research hypotheses. Time series data of stock indices from 2000-2018 is used
to conduct this research. Augmented Dickey-Fuller test, Autoregressive Integrated Moving Average and Generalized Autoregressive Conditional
Heteroscedasticity are the quantitative techniques used to measure the factors affecting the Pakistan stock market volatility, moreover, for contagion effect
testing the correlation coefficient test and Generalized Autoregressive Conditional Heteroscedasticity with an exogenous model are engaged in US,
UK and selected Asian countries. The analysis clearly shows that volatility trend is predictable based on historical trend as the variance equation of
Generalized Autoregressive Conditional Heteroscedasticity has a significant positive impact. The analysis also revealed that leading stock exchange indices
have a substantial impact on the Pakistan stock market. The study supports the argument for the international and national investors to hypothecate their
strategies to minimize the risk. Besides of this strategy, formulators may also change the results of these acquirements to inform the macro and micro stage
policymaking. Moreover, this study is used to fill the gap between the volatility prediction and contagion factors which have a significant impact on the capital market.
Keywords: Market Risk, Market Index, Volatility, Contagion Approach, Random Walk Theory