Impact of Interest Rates on Stock Market Performance: Evidence from Pakistan (2010–2024)

Abstract

This paper empirically examines how interest rates affect the performance of the Karachi Stock Exchange 100 Index (KSE-100) in 2010-2024 by using annual data on the Karachi Stock Exchange 100 Index (KSE-100), and the policy rate of the state bank of Pakistan (SBP). There is a detailed multivariate model that uses inflation (CPI), GDP growth, the USD/PKR exchange rate, and money supply increased (M2) as control variables. The study uses Ordinary Least Squares (OLS) regression using NeweyWest heteroskedasticity-autocorrelation-consistent (HAC) standard errors, unit root testing (ADF and KPSS), Johansen cointegration analysis, Granger causality tests, and Vector Autoregression (VAR) model with impulse Response Functions (IRFs) and Forecast Error Variance Decomposition Descriptive statistics indicate that the KSE-100 produced an average annual rate of 18.25% of returns (SD = 25.17%), whereas SBP policy rate yielded an average of 10.93% during the period of study. The results of the Granger causality tests indicate that the SBP policy rate Granger-causes KSE-100 returns at lag 1 (F = 5.24, p = .045), which is evidence of a statistically significant unidirectional causal relationship. The basic OLS (Model 3) captures about 14.92 percent of stock returns variations, which is not very huge considering the small sample size (N = 14). The model specifications are validated by diagnoses tests that show no heteroskedasticity, autocorrelation or non-normality of residues. These results have significant implications on the transmission of monetary policy, investor decision-making and development of the capital market in Pakistan.

Keywords: Interest Rates, Stock Market Performance, Kse-100, Monetary Policy, Pakistan, Granger Causality, VAR Model