A Raging Bull or a Long-term Speculative Bubble? The Puzzling Case of the Karachi Stock Exchange

Abstract

The objective of the study is to examine possible presence of nonlinear speculative bubbles in the Karachi Stock Exchange (KSE). Bubbles are argued to exist when there are substantial deviations of market value from the estimated fundamental values. We estimate a series of fundamental values from a four variable Vector Autoregression Model (VAR) using the main KSE100 index along with measures of world stock prices, the Pakistani exchange rate, and the Pakistani short-term interest rate. Residuals of this estimated fundamental time series are then tested for possible speculative deviations using a Hamilton regime switching test and a rescaled range Hurst coefficient test, with a further test for nonlinearity beyond the ARCH effects using the BDS statistic. For all of these, we reject the null hypotheses of the absence of speculative bubbles and nonlinearities beyond ARCH in these series. While these results suggest the possible presence of such bubbles, we note methodological limits on proving that due to the problem of mis-specified fundamentals. We further discuss some characteristics of the regulatory environment that may make it especially susceptible to such phenomena and may be considered by the policy-makers for the attenuation of speculative and manipulative behaviour. Keywords: Bubble, Pakistan, Stock Market, Regime Switching, Rescaled Range Analysis, Nonlinearity

Dynamics of price clustering in the Pakistan stock exchange

“…rendered untradeable). Likewise, Ahmed et al . (2016) find that around 60 stocks in PSX are traded frequently, and the remaining stocks are thinly traded or illiquid.…”

“…rendered untradeable). Likewise, Ahmed et al (2016) find that around 60 stocks in PSX are traded frequently, and the remaining stocks are thinly traded or illiquid. These inactive stocks have a negligible impact on the free float of PSX and their inclusion in the sample would bias estimates of our price clustering analysis.…”

“…PSX lacks both market depth and breadth. Ahmed et al . (2016) highlight that the stocks of only 10% of listed firms on PSX trade regularly and two dozen stocks account for 80% of daily trading volumes and market capitalization.…”

“…PSX lacks both market depth and breadth. Ahmed et al (2016) highlight that the stocks of only 10% of listed firms on PSX trade regularly and two dozen stocks account for 80% of daily trading volumes and market capitalization. Iqbal (2012) claims that PSX is among the most concentrated stock markets in the world, whereby a few stocks in heavyweight sectors like energy, banks and cement determine the performance of PSX.…”

Do rational bubbles exist in emerging markets of SAARC?

“…It is evident that the emerging stock markets show variances in the asset prices prevailing in the stock markets. Moreover, the evidence of the presence of the variances in the stock markets can also be linked to the existence of the rational bubbles (Ahmed et al , 2016). So it is necessary to study these emerging stock markets for the presence of rational bubbles, which will provide insights to the investors and help them in decision making.…”