Economic Exposure of Stock Returns in an Emerging Stock Market

The objective of the study is to examine the stock returns variation to specific economic variables by applying multi-factor model developed under Arbitrage Pricing Theory. The variables in the model are descriptive of the market and economic conditions of the country. The study attempts to determine which, if any, of the variables are of use in explaining the variability of stock returns of Pakistani Industries. These industries were selected on the basis of data availability, profitability and performance on the Karachi Stock Exchange 100 index. The data for the selected industries and economic variables obtained for the period of 10 years. GARCH technique used to analyze the risk and return relationship and to ascertain the usefulness of multifactor model over single factor model in explaining the variation in stock returns of Pakistani Industries. The results reveal that market return is largely responsible for the stock returns variation; however the inclusion of other macroeconomic variables has added additional explanatory power in describing the stock returns variation. Results also indicate that stock returns of different industries respond differently in similar economic conditions that acquaint investors about the risk diversification opportunity in the stock market.