Is stock market sensitive to foreign capital inflows and economic growth?

Abstract

Purpose – The purpose of this study is to investigate the impact of foreign capital inflows and economic growth on stock market capitalization in Pakistan by using the annual time series data from the period of 1976 to 2011. Design/methodology/approach – The autoregressive distributed lag bound testing cointegration approach, the error correction model and the rolling window estimation procedures have been performed to analyze the long run, short run and behavior of coefficients, respectively. Findings – Results indicate that foreign direct investment (FDI), workers’ remittances and economic growth have significant positive relationship with the stock market capitalization in long run as well as in short run. Results of the dynamic ordinary least square and the fully modified ordinary least square suggest that the initial results of long-run coefficients are robust. Results of variance decomposition test show the bidirectional causal relationship of FDI and economic growth with stock market capitalization. However, unidirectional causal relationship is found in between workers’ remittances and stock market capitalization. Practical implications – It is suggested that in Pakistan, investors can make their investment decisions through keeping an eye on the direction of the considered foreign capital inflows and economic growth. Originality/value – This paper makes a unique contribution to the literature with reference to Pakistan, being a pioneering attempt to investigate the effects of foreign capital inflows and economic growth on stock market by using long time series data and applying more rigorous techniques.