Relationship between Movement of Stock Prices and Bond Prices: A Case Study of Karachi Stock Exchange

Abstract

A potential investor may have different options for utilizing its excess ideal money but he will avail that option  where he can have maximum satisfaction in terms of profitability and security. However, the higher level of  uncertainty de-motivates an investor to employ his funds in a risky venture, especially during the period of  economic instability. As a result, one must evaluate the factors which act as a key determinant in the market  to boost up investors’ confidence. KSE has been termed as high risk high premium market by researchers,  so the higher persistence of volatility discourages an investor to rely on uncertain market. Instead he would  be more willing in fixed income securities or may opt for diversification of its portfolio. For this purpose  correlation analysis will be a helpful technique as it supports in asset allocation, portfolio selection and risk  management. It identifies the degree of dependency of one portfolio on another and helps in deciding the  correct proportion of allocation of funds on various assets. The two major forms of investment, stock and  bonds do follow a particular pattern in the market and by analyzing their trend one can opt for a proper mix  which will avert the risk associated with them. As per correlation analysis carried out on monthly data of KSE  100 and KSE all index from Nov 2003 to May 2009, it has been concluded that share indices have a positive  correlation with GDP, interest rate and money supply and a negative correlation with bond prices and T-bill rates. The regression analysis of the model presented the higher value of R square of 96%, which represents  the significance of the model.