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Share Prices Are Explained By The Real Shocks Finance Essay

This study has examined that among monetary shocks (∆M2) and real shocks of share price (∆SPt-k), which really explains share prices of tobacco industry in Pakistan. Monthly average data was collected from January 1991 to October 2010 containing money supply (M2), share prices of tobacco industry (Pakistan Tobacco, and Lakson Tobacco). Results of unit root test revealed that there is a real shock in share prices and it explains the share price of tobacco industry on temporarily while it is meagerly explained by the monetary shocks. Shortly the share prices of tobacco industry are explained by both the real and monetary shocks.



1.1 Overview

The economies of the world highly depend on the environment and surrounding. These include various economic and social factors, which affect the businesses. For several years the economic impact of the supply of money on share prices has been debated in the economics literature. This topic has retrieved popularity in the wake of recent share market volatility in the United States. This volatility has drawn the attention of many policy makers since the 1987 share market crash. The crash sent shock waves through the world's financial markets. Credit markets and commodity markets experienced sharp swings in response (Federal Reserve Bank of Kansas City Symposium Series, 1988). The crash and its accompanying swings have lifted the question of what, if anything can be done to moderate volatility in share prices. A debate has emerged concerning the design of monetary policy and possible intervening actions by the SBP in order to prevent a share market crisis similar to that of 1987 in US. In past researches, it has been observed that the rate of inflation is inversely proportional to the share prices in developing countries, while this relationship is somewhat neutral in developed countries such as USA and UK (Lessard 1980). Besides the associations between inflations and stock prices, the stock prices are explained by the number of players but more importantly by monetary shocks and even by the share prices lags i.e real shocks (Molson, 2009)

1.2 Research Problem

Inconsistent behavior of stock market and share price has been observed in different countries with respect to the fluctuations in Money Supply. Furthermore, type of industry is another factor which results in variation of the behavior. This study analyzed that the share price has the unit root or not and if not, then is the fluctuation in share price really explained and caused by the fluctuations in the money supply over the periods. The research emphasized upon the association of money supply and shocks in money supply for, specifically with the share price of tobacco industry (comprised upon the Pakistan Tobacco and Lakson Tobacco) in Pakistan.

1.3 Hypotheses

H1: The share price of Tobacco industry has the unit root.

H2: The Fluctuations in Money Supply explains the fluctuations in share price of Tobacco Industry.

H3: The Fluctuations in share prices for lag1 explains the current fluctuations in share price of Tobacco Industry.

H4: The Fluctuations in Money Supply causes the fluctuations in share price of Tobacco Industry.

H5: The Fluctuations in share price of Lakson Tobacco causes the fluctuations in share price of Pakistan Tobacco.

H6: The Fluctuations in share price of Pakistan Tobacco causes the fluctuations in share price of Lakson Tobacco.

H7: The Money Supply causes the share price of Tobacco Industry

1.4 Outline of the Study

The study includes the investigations of unit root in share prices of Tobacco Industry, along with the explanations of the fluctuations of these shares prices and the causes of such fluctuations.



The quantity theory of money (Brunner, 1961; Friedman, 1961; and Friedman and Schwartz, 1963) states that an increase in the money supply results in a change in the equilibrium position of money with respect to other assets, including equity shares, in the portfolio balance of asset holders. As a result, asset holders adjust the proportion of their portfolios represented by money balances. This adjustment alters the demand for other assets that compete with money balances, including equity shares. An increase in the money supply is expected to create excess supply of money balances and, in turn, excess demand for shares. Share prices are expected to rise as a result. This channel of interaction between changes in the money supply and share prices has been described by advocates of the quantity theory of money as the direct channel.

There are indirect channels of interaction between the money supply and share prices. These indirect channels focus on the impact of changes in the money supply on variables that guide investors' decisions concerning the allocation of their portfolios between money balances and alternative assets. A rise in the money supply creates excess supply of money chasing a limited amount of goods and services in the economy. In the context of mainstream rational expectations natural rate macro models, the resulting excess demand will affect real output and the price level in the short run, with magnitudes that are dependent on factors determining the slope of the short-run supply curve. In the long run, however, the full impact of the increase in the money supply will be absorbed in the price level. The resulting increase in the price level may stimulate inflationary expectations in the economy, which has a positive impact on the nominal interest rate. Higher nominal interest rates will affect investors' choices regarding the proportion of their portfolios to be held in terms of money balances because the nominal interest rate measures the opportunity cost of holding money balances. A rise in this opportunity cost will motivate asset holders to substitute other financial assets, including equity shares, for money in their portfolios.

Even though the direct and indirect impacts of the money supply on share prices have been recognized, this relationship has stirred another debate in efficient market models (Fama, 1970; Cagan, 1972; and Pearce, 1987). The debate has focused on the definition of efficiency and its implication concerning the time of the adjustment of share prices to changes in the money supply. Share prices in an efficient market reflect all publicly available information about the future profitability of firms. That is, historical data are useless in developing trading rules because such information already is incorporated in share prices. This implies that past changes in the money supply should not be able to predict share prices. These changes are caused by observed economic disturbances that had been reflected previously in share prices.

Changes in the money supply are hypothesized to lead changes in share prices. Whether the share market is efficient determines the lag length of the response of share prices to changes in the money supply. One can speculate, however, on the possibility of a causal relationship between share prices and the money supply. If the Fed counters shocks in the economic system with monetary policy, then a change in share prices may motivate Fed officials to vary the rate of growth of the money supply. A decrease in share prices caused by traders' increased pessimism may be interpreted as a signal of a possible recession. In an effort to counteract this possibility, Fed officials may expand monetary growth in order to boost share prices and reverse any contractionary signs. Changes in share prices may have a causal impact on the money supply according to this channel.

The above discussion suggests the possibility of bidirectional causality between share prices and money supply. Several investigations have examined the existence of this bidirectional causality. The econometric methodology and the findings of the various studies have varied. Sprinkel (1964) used a graphical approach to illustrate the relationship between changes in share prices and monetary growth. In contrast, Regalski and Vinso (1977) used cross correlation analysis to detect the bidirectional relationship between money supply and share returns. Other studies have utilized bivariate regressions for the empirical investigation of the relationship between money supply and share prices (Kraft and Kraft, 1977a; Sorenson, 1982; Pearce and Roley, 1985; and Mookerjee, 1987).

Other investigations have been concerned about various determinants of share prices including real output, the interest rate, and expected inflation (Kraft and Kraft, 1977b; Schwert, 1981; Pearce and Roley, 1985; James, Koreisha, and Partch, 1985; and Hashemzadah and Taylor, 1988). All these studies, except the latter study, have used bivariate regressions to analyze the relationship between share prices and their major determinants. But share prices involve a set of relationships that jointly explain the behavior of these prices because of the likely problem of simultaneity bias. A single estimation procedure may be inappropriate for what is essentially a system of equations.

James, Koreisha, and Partch (1985) used a vector autoregressive moving average (VARMA) model to examine simultaneously the links between share prices and their major determinants. Their empirical model comprises share prices, real output, the money supply, and the nominal interest rate as a proxy for expected inflation. While changes in the nominal interest rate reflect changes in inflationary expectations, the nominal interest rate may vary in response to changes in the real interest rate independently from expected inflation. Thus, it is preferable to account for expected inflation and the nominal interest rate independently as two measures of the opportunity cost agents consider as they compare shares to other assets in their portfolio balance. In addition, the current analysis departs from that of James, Koreisha, and Partch (1985) by employing new techniques that avoid the ad hoc assumptions used in earlier investigations for the determination of the lag structure and the direction of causality among the variables. Finally, James, Koreisha, and Partch (1985) end the sample period for their investigation in 1981. The excessive volatility that the share market has exhibited lately suggests the need for a fresher look. This investigation provides this fresher look at causes underlying the recent volatility of share prices from 1973:1 to 1991:1.

Cohn and Lessard (1980) found that there is a negative relationship between nominal inflation and share prices in many countries. From investor’s point of view, it is hard to trace the factors which are playing influencing part along with inflation in changing the stock market behavior. It was also found that factors including change in risk-free rate which affects long term earnings, variation in risk premium, and the variation in actual growth. It was also observed that there were systematic errors at investors end while calculating stock prices when there was high inflation.

Crosby and Otto (2000) analyzed inflation and its impact on capital stock using time-series data of many countries, and found that there is a long-term impact of inflation on capital stock in most countries where inflation is not super neutral. In most cases, it was quite difficult to trace any relationship between the two when there is neutral inflation behavior in a country. It also revealed that most economists consider a negative relationship between stock market and inflation. The reason for such behavior is due to inclusion of both public and private stock in analysis, while both stocks usually have different responses to the inflation. Inclusion of both created a thin line between near-to-none relation and a positive long-term impact.

It was suggested that individual countries must be analyzed first, reason stated, different factors are exclusive to countries which accounted as one of the reason. Interest, taxation, and impact of other economic factors on capital markets including private and public, can be treated separately and differences can be identified for a reliable analysis.

Garber (1982) argued that the hyperinflation in Germany resulted in some transition costs which were the results of non-subsidizing of investments in private sector. Similar behaviors from state authorities lead to a positive relationship among private stocks and the inflation. Furthermore, different treatments of tax department's nominal interest deductions and depreciation often results in such relationship between the two variables within a country.

Durre and Giot (2005) used Fed model to test the relationship between stock prices, earnings, and interest rates while aiming at the possibility of a long-term relationship. Fed model relates the government bond yield of 10 years with stock yield. It also argued the theoretical flaws of the model, and arrived at opinion that it does not take into account the issue of inflation illusion correctly. Therefore, its result incorrectly show lowered stock prices with the increase in inflation. While on the other hand, low inflation results in higher Price-to-earnings ratio.

During the analysis of 13 countries by Durre and Giot (2005), results showed that there is indeed a long-term relationship between earnings, stock prices, and bond yield in more developed countries such as United States and United Kingdom. But, the bond yield's relationship is not as significant, and therefore it does not affect stock market equilibrium significantly. Considering the short term impact, a relationship between stock returns and bond yield was found. It was due to the reason that most analyst emphasize on valuation ratios such as price-to-earnings ratio. Argument that low earning yields and high stock prices are the result of low interest rates was proved wrong.

Examining the relationship among macroeconomic variables and stock market, Adam and Tweneboah (2008) revealed that macroeconomic variables such as inflation, interest rates, net foreign direct investment and exchange rate have a significant impact on share prices in the long run. This long-run analysis was tested using Johansen's multivariate co-integration test. It also revealed the positive correlation between inflation and share prices. Similar findings were from Anari and Kolari (2001) where results also revealed that stock market provides hedge against inflation, while long-term relation was evident among inflation and share prices.

Comparing interest rates, FDI, exchange rate and inflation as an impacting factor on share prices, as tested by Adam and Tweneboah (2008), the interest rates affects the share prices more significantly than inflation and therefore it was an indicator for investors to pay attention on interest rates. Foreign Direct Investment and Exchange Rate's impact were next in line. CPI's impact is minimal when compared to those macroeconomic variables.

Analysis of relation between inflation and real stock returns by Day (1984) showed a consistent negative correlation between the two variables. It argued that inflation is directly created and controlled by economy's supply of money by government. Analyzed was the market with equilibrium and rational investors. The opinion varied when it studied the relation of other economic factors and relationship beyond just inflation and asset pricing. The model suggests the variability in asset pricing and it implies that consumption and investment decision of a firm results in variability in consumption which is lower than the total output. The rational expectations and market efficiency were seen consistent with the variability of asset prices.

Fama (1981) is of the opinion that there is a negative relationship between share prices and inflation. It argued that this is because of a prominent negative linkage among inflation and real activity. While, positive relation is found between share prices and real activity. Since the 3 variables are linked to each other, the final share prices and inflation have an inverse relation. Later the evidence is mixed when negative coefficient turns insignificant in the regression after base money growth is also added to the model. Nevertheless, the share prices always reacted negatively to the inflation. On the other hand, the movement of share prices is considered positive with inflation since returns from real assets are claimed to be real returns. Therefore, the shares are considered a hedge against inflation.

Kool and Hafer (1986) research based on the findings of Fama (1981) and argued that negativity of stock prices and inflation is because of a inverse correlation between unexpected inflation and the output. Evaluating the post-1950 period it is found that real activity has an impact on share prices and the impact of inflation on share prices is quite different from zero. Post 1980 results favor the Fama Hypothesis. While, the results from pre-1950 period goes straight in favor of orthodox theory where a positive correlation between real activity and stock returns noticed dominating the inflation impact and future activity.

New York Stock Exchange Index declined by 68 percent during 1965 to 1981, and the dividends and returns were fallen close to zero during the period. As suggested by Fama (1981), the higher inflation rate is the main reason that caused such downfall in the market. It was also observed that tax system was also to be blamed for higher inflation which resulted in share price issue.

Feldstein and Martin (1980) also argued that tax system is somehow responsible for the inflation. Historic cost method of depreciation and capital gain taxation are the factors which cause the stock returns to fall with the increase in inflation. While, it also decreases the value of the debt a firm holds, and therefore the return on bonds are also reduced. The expectation of increase in tax and inflation has an effect to some extent on share prices.

Another reason was debated by Malkiel (1979) suggesting that the decline of Stock Exchange in USA occurred while there was an evident risk of capital investments during 1970s. It shows that impact on a firm's capital due to gross marginal return increased after 1965 which also resulted in the riskiness of investor' returns from holding stocks. Increase volatility of stock returns is also observed which shows the variance of return on NYSE Index. During the period, variance continued to increase, and this fluctuations caused variation in firm's gross marginal return on capital and increment in variance of inflation as well. Unforeseen events, such as, fluctuations in regulatory, exchange rate, and competition of market players, that affect capital gains and losses are usually unrealized. Thus, it makes it difficult to measure the return on capital smoothly. But, the variance can still be calculated from the data available at stock markets. Malkiel is of the opinion that whatever these fluctuations do, but it definitely affect the business environment and makes it more uncertain.

Fama (1981) results also points indirectly to the correlation real economic variables and gross marginal return on capital. The volatility of gross return is linked to the volatility of inflation, which has a negative correlation with returns when unanticipated. On another end, volatility is also responsible for riskiness of bonds. Though, it is unclear if this volatility increases the share value while making bonds riskier, and not the other parameters such as tax rates.

Pindyck (1983) found that behaviour of gross marginal return on capital is the actual reason affecting share prices. Analysis discusses that there are controversies regarding the variance since results showed it doubled while other authors are of the opinion that expectation of return fell. The two changes actually depend on how investors consider this risk and make decisions accordingly, analysis suggests. Developed model is simple and only utilized asset returns, asset demands, and share prices. Though, the model limiting factors were known to be reliance on rational share valuation, income streams in consumption, and consideration of only two assets in portfolios. Use of a partial equilibrium framework was also another limiting factor. These limitations made it difficult to analyze the results but to an appreciable extent, it proved that share price increases when there is an increase in capital stock, while there is a negative relation between inflation and returns.

Investor's perception of risk is another issue Pindyck considers difficult to measure. Analysis emphasized that it can be measured to a good acceptable level using sample variance of stock market returns, but the use of survey data is even better in measuring it. Analysis also argued that non-negligible probability of economic catastrophe makes the capital risky even if the volatility in stock returns does not exist.

Subhani (2010) found that there is a relationship between KSE-100 Index and CPI. Though, the relationship is negative. Analysis also found that it is participant's perception which causes inconsistent effect to trading. Participant’s response to the CPI announcements varies and causes declining trade volume variably.

Schwert (1981) analyzed daily stock returns and concluded that any unexpected inflation or a negative news regarding stock market reacts in a negative response from stock market as well. Meaning, if inflation rises, the stock price falls.

Feldstein (1983) found that higher inflation rate results in decreasing ratio of share prices to before-tax earnings. The main factors that cause it are historic-cost depreciation and the increasing tax on capital gains. Both factors, caused by inflation, decrease the return on capital. It also revealed that investors are often responding differently to tax related news, and at times the share prices fall even if the demand price per share is increased by inflation (Feldstein, 1983).

Husain and Mahmood (1999) analyzed eight years of data from June 1991 to June 1999, consisting of money supply and share prices from five sectors in Pakistan. Analysis found that there is a long-term relationship between share prices and money supply (M2). One way causation was found for share prices from M2. Analysis also revealed that change in money supply also affects the share prices in short term, and therefore, stock market is not considered efficient with regards to money supply and past monetary assets information. Results concluded that money supply is helpful in predicting the share prices movements.

Davidson and Froyen (1982) found that stock market is responsive to the monetary news, and prices move with respect to change in money supply. Analysis further revealed that unanticipated money growth actually has no impact on share prices, but when only past money supply information is used for predicting future money supply, it does have an impact on stock returns and hence share prices. Therefore, results also concluded that there are factors which cause stock market inefficiency, which is efficient when only money supply data with its historical information is considered. Share prices are not affected quickly. Rather, it takes about a year to reflect a change in stock return and share prices. Having said this, stock returns and prices fall when there is an increase in money supply.

Alatiqi and Shokoofeh (2008) found that money supply causes the positive impact on stock prices. Such relationship is the result of perceived inverse relationship between money supply and interest rates, and the inverse relationship between interest rates and share prices. Analysis argued that negative relation between money supply and interest rate is not stable, causing the instable relationship among interest rates and share prices, which results in insignificant long-term relationship between share prices and money supply. Analysis suggested that the distortion in expectation of change in interest rate due to the change in money supply results in absence of relationship between interest rates and money supply in the economy. While, short-term liquidity effect causes the inverse relationship between money supply and interest rates. Money market equilibrium is resulted when interest rate is decreased with the increase in money supply. On the other hand, there is still an uncertainty in relationship between interest rates and share prices. Analysis argued that according to traditional views increase in interest rates result in higher borrowing costs for a firm, which also results in decrease in profits, and therefore causes the share prices to decrease. While, study suggested that profits and share prices do not change if interest rate and demand for a firm's products are increased simultaneously. Decreasing interest rates force investors to pull money from bond market and invest in equity market, and it results in expectation of further declines in future. Additionally, it also indicates the possibility of making profits at lower risk and therefore results in many investors not pulling out investments from bond market.

Pesando (1974) argued that change in money supply affects share prices to very low extent. The prices are rather linked to risk and return, which share the major role in determining the stock prices. Analytical models used for predicting share prices using money supply only explain the level of share prices and are not considered a true determinant of stock market.

Puah, Habibullah, and Liew (2009) found that there is no long-term neutrality between share prices and money supply, and equilibrium is not achieved either. Instead, stock market is inefficient with respect to money supply. Expansionary monetary policy results in positive impact on share prices. Increased money supply improves the liquidity position of the economy, and therefore demand for shares in stock market is increased. It was also noticed that at first share prices decrease when investors pull out the investments, but the demand increases when the prices are lower and it increases the price in the market. Analysis insisted that stock agents are the important factor in maintaining the share prices. Anticipated future fluctuations are used as a tool by agents to make profits by controlling the demand and supply of the stock market to a considerable extent. Policymakers consider negative relationship between share price and money supply, but it actually increases the share prices when inflation is included in the expectations of people and future anticipation of results. Therefore, the factors considered by people further distort the result leaving unanticipated factors playing a real role in moving share prices.

Homa and Jaffee (1971) found that share prices have positive relationship with the money supply. Research observed that the impact is visible in long term, and it is relatively to a lower extent. Beside money supply alone, the growth rate of dividends, risk-free interest rate, and risk premium are the major indicators of share prices. Firm's performance is affected by the money supply in long-term, and it accounts for increase in price after demand is increased due to decreased share price at an initial stage.

Kraft and Kraft (1977) indicated that money supply has no significant causal relationship with share prices. Money supply poses a less likely forecasting ability and does not affect a variation in stock markets to a considerable extent. Even if the market is efficient, comparing past and current money supply information is not a good indicator for share prices. Analysis explained the equity market efficiency and asset prices with respect to all actual and expected information, and suggested that stock prices based on current and past movements in money supply are not influenced.



3.1 Method of Data Collection

Secondary data was used for conducting the research. Data of money supply was collected from Federal Bureau of Statistics ( and Economic survey of Pakistan. Share prices tobacco industry comprised upon Pakistan Tobacco and Lakson Tobacco was collected from and Taurus Securities, a capital management firm.

3.2 Sample Size

A sample of 238 observations has been used in the study. Monthly Money supply M2 from January 1991 to October 2010 has been used, while daily share price of tobacco industry were converted into monthly averages for the same period.

3.3 Research Models /Econometrical Models

There are several econometrical Model used to investigate the all formulated research hypotheses.

For the testing the unit root in the data of share prices of tobacco industry, when SP (Y) is trended, the unit root test was applied but vector auto regression was also used to

justify the application of unit root test. Following is the econometrical equation of unit root test.

DYt = αYt-1 + x’t + b1DYt-1 + ……… bpDYt-p + ETt

The following Granger representation theorem/ error correction model was used to test the hypotheses except of hypothesis of causality and unit root, the following model was developed and used to confirm the findings of unit root test

DYt = C + b1DM2 t – 1 + b2DM2 t – 2 + b3DYt – 1 + b4DYt –2 + ETt

Where, Y= Share prices of tobacco Industry

Moreover, to check the causality, the Bivariate Granger causality was also applied as Bivariate Granger causality tests for two variables X and Y evaluate whether the past values of X are useful for predicting Y once Y's history has been modeled. The null hypothesis in this connection is that the past p values of X do not help in predicting the value of Y.



TABLE: 4.1







[ 21.2068]









[ 1.40660]



 Adj. R-squared


 Sum sq. resids


 S.E. equation




 Log likelihood


 Akaike AIC


 Schwarz SC


 Mean dependent


 S.D. dependent


Included observations: 236 after adjustments

Standard errors in ( ) & t-statistics in [ ]

TABLE: 4.2


Null Hypothesis: Share prices of TOBACCO INDUST has a unit root



Augmented Dickey-Fuller test statistic



Test critical values:

1% level


5% level


10% level


Exogenous: Constant

Lag Length: 1 (MAXLAG=14)

Augmented Dickey Fuller Test Equation

Dependent Variable: D(TOBACCO INDUST)

Method: Least Squares

Sample (adjusted): 3 238

Included observations: 236 after adjustments


Std. Error




















    Mean dependent var


Adjusted R-squared


    S.D. dependent var


S.E. of regression


    Akaike info criterion


Sum squared resid


    Schwarz criterion


Log likelihood


    Hannan-Quinn criter.




    Durbin-Watson stat




The ADF statistic value is -1.1337 and the associated one-sided p-value (for a test with 236 Observations) is .7027. In addition, EViews reports the critical values at the 1%, 5% and 10% levels. Notice here that the statistic value is greater than the critical values so that we do not reject the null at conventional test sizes means that the Share price of TOBACCO INDUST has an unit root.

The simple Dickey-Fuller unit root test described above is valid only if the series is an AR(1) process. If the series is correlated at higher order lags, the assumption of white noise disturbances is violated. The Augmented Dickey-Fuller (ADF) test constructs a parametric correction for higher-order correlation by assuming that the series follows an AR(p ) process as it has been shown in the table of VAR SP of TI that the series for share prices of tobacco industry has been following the AR process and the series is significantly explained by the lag1 and lag2 of the series while DW= 1.9 explains that series is not correlated at higher order thus the assumption of white noise disturbance is not violated , Moreover, the strong F-Statistics (6883.834) shows that AR model comprised upon the two lags is highly significant. Thus adding lagged difference terms of the dependent variable to the right-hand side of the test regression for the unit root:

DYt = aYt – 1 + xt + b1DYt – 1 + vt

-0.00963 1.562 0.382941

[ -1.133] [1.4066] [5.91420]

Where, Y= Share Prices of Tobacco Industry

In the above equation 1, xt is optional exogenous regressors which is comprised on constant in the above equation, the a and b1 are the parameters of Yt-1 and DYt-1, which are estimated 0.00963 and 0.382941 respectively, the t value (5.91420) in the parentheses for b1 explains that the change in Yt-1 explains significantly to change in Yt. As it can be seen that a < 1 (i.e. a = -0.00963 at t = -1.133 > critical values) means that the Share price of TOBACCO INDUST has an unit root and hence the series is a

non- stationary series. The failure in rejecting the null hypothesis which implies the presence of unit root, confirms that the series is a non-stationary series and also confirms that there is a real shocks in share prices ( DYt-1) which explained the fluctuation in Share prices ( b1= 0.3829 at t= 5.9142) but this real shock ( DYt-1) is not permanent and is temporary since only a ≥1 implies the permanent shocks.

TABLE: 4.3









[ 1.83398]




[ 1.29144]




[ 6.18302]








[ 0.51504]



 Adj. R-squared


 Sum sq. resids


 S.E. equation




 Log likelihood


 Durbin Watson


 Mean dependent


 S.D. dependent


DYt = C + b1DM2 t – 1 + b2DM2 t – 2 + b3DYt – 1 + b4DYt –2 + ETt

0.39163 4.82E-06 -5.01E-06   0.45925 -0.0271

[0.5150] [1.84] [ 1.29144] [6.1830] [0.359]

The above findings translate that from the above stated variables in the model, only fluctuation in money supply (DM2) for lag1 and fluctuations in shares prices also for lag1 are significantly explaining the fluctuations in share prices of tobacco industry for the current period, as the b1 of DM2 t – 1 = 4.82E-06 at t = 1.84, while b3 of DYt – 1 = 0.45925 at t = 6.18. The stated statistics revealed that the fluctuation in money supply for the very previous period i.e a monetary shock explains the current fluctuations in share prices of tobacco industry , while lag1 of change in shares prices also explaining the current fluctuation of the share prices which in short confirms the findings of unit root test.

TABLE: 4.4


Null Hypothesis:




M2 does not Granger Cause SP of TOBACCO INDUSTRY




M2 does not Granger Cause change in SP of TOBACCO INDUSTRY




Change in M2 does not Granger Cause change in SP of TOBACCO INDUSTRY




SP of LAKTOBAC does not Granger Cause SP of






SP of PAKTOBAC does not Granger Cause SP of






The findings of Granger causality test has portrayed the very interesting stories which includes that M2 for the previous lag significantly causes the share prices of Tobacco industry, while the current fluctuations in M2 does not necessarily cause the current fluctuation of share prices of Tobacco industry but as per the findings of Granger representation theorem, the fluctuation in M2 for the very previous period significantly explains and impacts the current fluctuations in the share prices of Tobacco industry. Moreover, The Granger causality test also suggest that tobacco industry in Pakistan is the reflections of duopoly leaded by the Lakson tobacco as the industry leader since, the share prices of Lakson tobacco significantly cause the share prices of Pakistan tobacco.

Figure 4.1

Trend of Share Prices in relations with Money Supply (M2)

Figure 4.1 reveals the trend of share prices Tobacco Industry in Pakistan. It suggests that Share Prices of Tobacco Industry with relation to the Money Supply rose in the beginning. It fell, and then again increased at the end. Trend of Share Prices in relations with M2 are showing growth with the span of time.

TABLE: 4.5

Hypotheses Assessment





Empirical Conclusion

H1: The share price of Tobacco industry has no unit root.

 1.1337 > All 3 Critical Values



H2: The Fluctuations in Money Supply explains the fluctuations in share price of Tobacco Industry.




H3: The Fluctuations in share prices for lag1 explains the current fluctuations in share price of Tobacco Industry.







Empirical Conclusion

H4: The Fluctuations in Money Supply causes the fluctuations in share price of Tobacco Industry.




H5: The Fluctuations in share price of Lakson Tobacco causes the fluctuations in share price of Pakistan Tobacco,




H6: The Fluctuations in share price of Pakistan Tobacco causes the fluctuations in share price of Lakson Tobacco.





H7: The Money Supply causes the share price of Tobacco Industry.




Note: All hypotheses are alternative hypotheses which is tested at p< 0.05




5.1 Conclusions and Discussions

This investigation focuses on Money Supply and its fluctuations as the determinants of changes in share prices in view of the recent volatility of share prices in tobacco industry of Pakistan. A vector autoregressive technique, unit root test, Vector correction model and Granger causality were used to investigate the data and hypotheses. The applied econometrics allows for the simultaneous interaction of variables relevant to the determination of share prices. The model includes share prices for the Tobacco Industry and money supply (M2).

The results are consistent with a direct impact of changes in the money supply and change in share prices for very previous lags on the current changes in share prices (findings of Granger representation theorem/ error corrections model for H2 and H3). This impact is significant, with a very previous lags that questions the validity of the share market efficiency. It is interesting to note that of the studies cited in this research, only the evidence of Hashemzadah and Taylor (1988) is consistent with this conclusion. This observation may suggest that, aside from differences in the econometric methodology, the inefficiency of the share market may be a characteristic of the recent years distinguishing the current sample period,

The direct causal impact that the money supply has on share prices was observed in this study (the findings of Granger causality test for H7) can also be is reinforced through the indirect channels suggested in theory. Changes in the money supply have causal impacts on the interest rate and the inflation rate that are transmitted to share prices indirectly through the causal impact that these variables have on share prices. Some aspects of this indirect relationship find support in other studies; Pearce and Roley (1985) and Hashemzadah and Taylor (1988) report evidence on the causal impact that the interest rate has on share prices. In addition, Schwert (1981) finds evidence of a significant impact that inflation has on share prices.

The failure in rejecting the null hypothesis/ or the failure in accepting the alternative hypothesis about the unit root in data of share prices of tobacco industry implies the presence of unit root, confirms that the series is a non-stationary series and also confirms that there is a real shocks in share prices ( DYt-1) which explained the fluctuation in Share prices ( b1= 0.3829 at t= 5.9142) but this real shock ( DYt-1) is not permanent and is temporary since only a ≥1 implies the permanent shocks (findings of Unit root test for H1). This relationship qualifies share prices to serve as a leading indicator of economic conditions, as suggested by Fama (1981). A reduction in share prices for the current year serves as a signal for possible future reductions in share price of tobacco industry and hence a possible future recession the findings of unit root also suggested that the stated real shocks would likely to be not permanent.

The another interesting findings ( the findings of Granger causality test for H5 and H6) also revealed that tobacco industry in Pakistan is the reflections of duopoly leaded by the Lakson tobacco as the industry leader since, the share prices of Lakson tobacco significantly cause the share prices of Pakistan tobacco

5.2 Policy Implications

Despite the significant impact that monetary growth has on fluctuations in share prices and the significance of these fluctuations on real activity, State Bank of Pakistan (SBP) officials have not considered change in share prices as a factor in their design of monetary policy. The evidence of this research leads to the following conclusion. There is a clear channel through which the monetary authority can affect the volatility of share prices. SBP officials should develop the monetary policy by pondering on the stock market fluctuations and they need to consider these fluctuations more formally if the stability of real output growth continues to be a high priority item among the objectives for monetary policy.


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