Stock Prices, Real Sector and the Causal Analysis: The Case of Pakistan

This paper re-examines the causal relationship between stock prices and the variables representing the real sector of the Pakistani economy.Using annual data from 1959/60 to 2004/05, examining the stochastic properties of the variables used in the analysis, and taking care of the shifts in the series due to the start of the economic liberalization program in the early 1990s, the paper investigates the causal relations between stock prices and variables like real Gross Domestic Product (GDP), real consumption expenditure, and real investment spending. The analysis indicates the presence of a long run relationship between stock prices and the real sector variables. Regarding the cause and effect relationship, the analysis indicates a one-way causation from the real sector to stock prices implying that the stock market in Pakistan is still not that developed to influence the real sector of the economy. Hence the market cannot be characterized as the leading indicator of the economic activity in Pakista