‘Assesing the impact of the Economic-meltdown on the Liquidity, Volatility and Efficiency of the Karachi Stock Exchange’

Abstract

The term liquidity is used in various ways, all relating to availability of, access to, or convertibility into cash. In a stock market, liquidity refers to the asset’s ability to be easily converted through an act of buying or selling without causing a significant movement in price. Apart from liquidity, the volatility and efficiency of the market also are defining characteristics of a market. Volatility means, how much the price of a security rises or falls during a short period of time, while efficiency of a market reflects how quickly the market adjusts to information and incorporates all available information in its stock prices. The monitoring of market liquidity is vital to the finance industry, policy makers and regulatory bodies. Not only is it very expensive and sometimes impossible to unwind or hedge a position when the market is illiquid but it has also been argued that illiquidity is the immediate cause of financial crisis and contagion. When a company seeks to float its new shares, the liquidity and volatility situation in a market can affect the initial share price to be offered and hence the finances to be gathered from the public. So, the more liquid and less volatile a market, the more attractive it would be for potential investors. However, certain economic phenomenon can affect the liquidity and volatility of the stock market. One such recent event of the global economic meltdown is taken into account in this report and its corresponding effects on volatility, liquidity and efficiency on the Karachi Stock exchange are analyzed. For Pakistan, the crisis was more domestic in nature but at the same time the global crisis also played its role in terms of the flight of international investors and their investments in our market. They also became overly cautious in their investment strategy; this meant there would be stagnation in the market. Due to these reasons and other domestic reasons, the Karachi stock exchange took a hit and the index plunged to record low levels. To save the 2 situation from further deterioration, the stock market was suspended at 9,144 points, whether this solved the situation or made it worse is still debatable. Apart from the liquidity and the volatility aspects, the efficiency of a market to incorporate information into its stock prices quickly, also exhibits the financial health of a financial market, like a stock exchange. In this report, the efficiency of the KSE will be analyzed whether it is weakly-efficient or not. Moreover, the effect of the economic crisis will also be analyzed on the efficiency of the market to see if there was any change brought about on this aspect.