A Raging Bull or a Long-term Speculative Bubble? The Puzzling Case of the Karachi Stock Exchange

Ehsan Ahmed, J. Barkley Rosser Jr., Jamshed Y. Uppal

Abstract


The objective of the study is to examine possible presence of
nonlinear speculative bubbles in the Karachi Stock Exchange (KSE).
Bubbles are argued to exist when there are substantial deviations of
market value from the estimated fundamental values. We estimate a series
of fundamental values from a four variable Vector Autoregression Model
(VAR) using the main KSE100 index along with measures of world stock
prices, the Pakistani exchange rate, and the Pakistani short-term
interest rate. Residuals of this estimated fundamental time series are
then tested for possible speculative deviations using a Hamilton regime
switching test and a rescaled range Hurst coefficient test, with a
further test for nonlinearity beyond the ARCH effects using the BDS
statistic. For all of these, we reject the null hypotheses of the
absence of speculative bubbles and nonlinearities beyond ARCH in these
series. While these results suggest the possible presence of such
bubbles, we note methodological limits on proving that due to the
problem of mis-specified fundamentals. We further discuss some
characteristics of the regulatory environment that may make it
especially susceptible to such phenomena and may be considered by the
policy-makers for the attenuation of speculative and manipulative
behaviour. Keywords: Bubble, Pakistan, Stock Market, Regime Switching,
Rescaled Range Analysis, Nonlinearity

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DOI: https://doi.org/10.30541/v55i2pp.79-93

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