INTRODUCTION:

The topic of my research is Impact of political instability on the performance of stock market of Pakistan. To my opinion, political instability is a situation where by a country is currently going through political turmoil. It may also involve the death of people within that country, change of regimes and nature of the government. And as a result of political instability, in many cases the country deteriorates in terms of its economic progress. I would be highlighting the impact of major political instability incidents over the recent past in Pakistan and its impact on the Pakistani Stock Market. This means that my research is focused on the performance of stock market with relation to the political forces and how investors react to those forces.

Literature Review

Leblang & Mukherjee(2005) said that the causal logic underlying the central claim in democratic politics and financial markets literature-that the value of financial assets decrease but becomes increasingly volatile under left-wing governments is rooted in extant research on the effects of partisanship on the economy (e.g., Alt and Crystal 1983; Hibbs 1987). Herron (2000) argued that since traders anticipate higher (lower) inflation under a left-wing (right-wing) incumbent party, they rationally expect a decline (increase) in the real returns of stocks when the left (right) party wins elections and assumes office. Exante expectations of lower (higher) stock returns increases (decreases) uncertainty about the possibility of a stock market revival in the future, which leads to higher (lower) stock market volatility. A cursory view of the data revealed that the assumption of partisan- ship having discernible effects on inflation in the causal story described above is accurate. A difference in means test for inflation rates by presidential administration for the United States between 1900 and 2000 indicates that inflation is statistically higher during democratic administrations (p = 0.00). This result holds even if we drop the years when Jimmy Carter held the Presidency.They obtain similar results showing inflation being higher under Labor as compared to Conservative governments in Britain between 1940 and 2000 (p = 0.00). While the assumption linking partisanship to inflation are borne out the bulk of the partisan politics and financial markets literature rests on two faulty assumptions. First, existing studies ignore that if traders anticipate stock returns to decline under a Democratic (Labor) government, then they have a rational incentive to reduce their volume of trading. If the volume of trading declines, then stock price volatility will decrease since it is well known from empirical studies in financial economics that a decline in trading volume leads to lower market volatility (Gallant, Rossi, and Tauchen 1992). Second, if traders expect higher stock returns under a right-wing administration, then trading volume and capital inflows into the market increases rapidly, which leads to higher stock price volatility (Kothari and Shanken 1992).

Beaulieu & Cosset(2006) said that the short run effect of the 30 October 1995 Quebec referendum on the common stock returns of Quebec firms. Their results showed that the uncertainty surrounding the referendum outcome had an impact on stock returns of Quebec firms. They also found that the effect of the referendum varied with the political risk exposure of Quebec firms, that is, the structure of assets and principally the degree of foreign involvement. Their results indicated that the short-run effect of the referendum results on stock returns is positive and statistically significant for all four portfolios. This evidence suggests that the outcome of the 1995 referendum was not predictable. Yet, as discussed in Brown, Harlow, and Ticnic (1988), their results were consistent with the unexpected information hypothesis. That is, they can attribute the referendum results to the resolution of the uncertainty over Quebec political future. Furthermore, the fact that Quebec would remain within the Canadian federation probably was good news to financial markets, given the positive reaction of financial markets to the referendum outcome. If the referendum outcome had been negatively interpreted, there would probably have been no reaction, given the large decrease in market level when it became clear that the referendum outcome could not be anticipated. This further suggests that investors might have associated the NO vote in the 1995 referendum with a reduction in economic and political instability, although this cannot be directly inferred from their results. Nonetheless, their results clearly 640 M.-C. Beaulieu, J.-C. Cosset, and N. Essaddam reveal that political uncertainty can affect short-run stock returns of Quebec and Canadian firms when the uncertainty cannot be anticipated by financial markets. They also noted that the effect of the uncertainty about the referendum on portfolio returns is larger for firms most exposed to political risk than for firms less exposed to political risk. The impact of uncertainty resolution is less important for multi- national firms than for domestic firms. However, this result does not appear to be statistically significant for growth option characterizations.

G.KAUL H. SEYHUN (1990) talked about the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence showed that the negative stock return- inflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability. This paper investigated the effects of relative price variability on output and stock returns and gauged the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence showed that the negative relations between stock returns and expected and unexpected inflation proxy for the negative effects of relative price variability on the stock market. However, the adverse effects of relative price variability on output and the stock market are largely a reflection of the supply shocks witnessed in the seventies. The OPEC oil crisis of 1973-1974, in particular, appears to have had a major detrimental effect on output and the stock market. Nevertheless, controlling for the effects of future output growth does not attenuate the effect of relative price variability on stock returns. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link suggested by Fama (1981) and the supply shocks reflected in relative price variability particularly in the seventies

F. Renshaw(1967) explained that the adjustment process which is implicit in portfolio theory and show how this process enriches our understanding of financial instability. When the model is applied to debit balances held with brokerage firms belonging to the NYSE we can show that the stock market panics of 1962 and 1966 cannot be blamed on increased speculation and are forced to conclude that these declines were the result of poor management on the part of institutional investors. About 80 percent of the year to year percentage variation in debit balances belonging to customers of the New York Stock Exchange can be explained by variations in the annual returns-price appreciation plus dividends expressed as a percent of price at the beginning of the year-associated with S & P’s composite stock index during the 12 year period from the end of 1953 through 1965.Only ten of 26 declines of ten percent or more which occurred in S & P’s monthly price index before World War II were less than 24 percent. Since World War II there have been nine declines of ten percent or more and none of these persisted long enough to register more than 23.3 percent on a monthly basis. This difference does indicate a more stable stock market which ought to provide a foundation for greater courage in the wake of declining stock prices. As more investors begin to perceive that stock market panics have provided an opportunity to make a handsome profit with very little risk, we ought to achieve an equilibrium condition in the stock market that can better withstand shocks and be considered self-stabilizing.

GL Kaminsky & Schmukler (1999)s