Foreign Financial Inflows and Stock Market of the Host Country:Empirical Evidence from Pakistan

Abstract

Foreign inflows play an important role in boosting the financial system and economic growth of a country. This paper aims to explore the impact of foreign financial inflows on the progress of stock market of a developing country like Pakistan. The study also intends to identify the relationship between foreign financial inflows and stock market development and to observe its short and long run dynamics. Variables like inflation, large scale manufacturing index and exchange rate are included in the study to determine stable stock market. For this purpose, monthly data from July 2001 till June 2012 is collected and analyzed through E-views statistical package. The vector error correction model (VECM), cointegration analysis and multiple regression analysis are opted for as part of methodology. The result shows that foreign financial inflows have a positive and significant impact on stock market returns.Moreover, the relationship between inflation and stock market returns is also positive, while there is a negative relationship of exchange rate and large scale manufacturing index with stock market returns. It is, thus, recommended that policies that attract foreign inflows should be pursued in order to improve stock market returns.