Factors Affecting Portfolio Investment in Pakistan: Evidence From Time Series Analysis

Author:IMRAN SHARIF CHAUDHRY FATIMA FAROOQ and ARZOO MUSHTAQ
 
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Abstract. This study is an endeavour to establish the factors that affect the portfolio investment in Pakistan. Portfolio investment is one of the main components of private investment. Portfolio investment is helpful to fill the gap between savings and investment in Pakistan. Time-series annual data have been taken for the period 1981-2012. This study employs Autoregressive Model of partial adjustment with least-square method. Net Portfolio Investment (NPI) has been taken as dependent variable whereas market capitalization weighted average rate of return on deposit trade openness broad money (M2) one period lagged dependent variable and Foreign Direct Investment (FDI) have been taken as independent variables. The study concludes that FDI has negative impact on NPI while all other variables are positively related to NPI. The Government of Pakistan should defend its financial sector from terrorism and its effects.

Keywords: Net portfolio investment Foreign direct investment Market capitalization Trade openness M2 Weighted average rate of return on deposit Pakistan

  1. INTRODUCTION

    Investment is the loyalty of money or capital to purchase financial instruments and other assets in order to receive profitable returns in the form of interest as well as the positive reception of the value of the instruments. Most of the studies emphasized on the positive aspects of foreign capital on economic growth. Foreign capital improves the process of economic growth by filling the gap between savings and investment. Foreign capital flows are divided into two types: foreign aid and foreign private investment. Foreign private investment is the most important source of foreign capital. Foreign private investment is further divided into Foreign Portfolio Investment and Foreign Direct Investment.

    Portfolio investment is a cluster of financial investment instruments. These financial instruments are easy to trade and are less eternal. These instruments are not unavoidably a representation of long-run interest. It includes stocks bonds debt securities dividends and mutual funds of different businesses from abroad and domestic. This type of investment gives the investors dividend payments possible voting rights and ownership of a part of the company. This type of investment represents usually short-term interest as it is considered more volatile and uncertain.

    These financial assets Portfolio Investment are highly liquid in nature and easy to convert into currency in any time. Asian Economic Crisis of 1997 occurred due to high volatility of Foreign Portfolio Investment. Large amount of assets have converted into cash at the time of financial crisis. Investors can sale their financial instruments from portfolios at any time depends on investor's choice. In this thesis NPI has been taken as dependent variable. NPI is attained by subtracting debit from credit in portfolio investment flows.

    Portfolio investment will lead to a capital structure of firms in Pakistan by improving the managerial incentives and firm's value. When portfolio investment will rise it will lead improvement in Pakistan economy as it will improve opportunities of employment business sector performance per capita income GDP growth exchange rate stabilization and balance of payment improvement etc. Portfolio investment flows will also increase foreign reserves in Pakistan with a positive impact on stabilization of exchange rate. This study on factors affecting the portfolio investment in Pakistan is very important especially because of a very high market risk and geopolitical situation of Pakistan. As Foreign Portfolio Investment (FPI) is a main source that can attract foreign investment towards Pakistan in the situation of high market risk.

    Foreign portfolio investment has proved to be more volatile and sensitive to the changes in its determinants in the Asian Financial Crisis. This study discusses factors that affect portfolio investment in Pakistan with evidences from time series analysis. Study tries to find out the relationship between Net Portfolio Investment market capitalization M2 Foreign Direct Investment and trade degree of openness. This study assists in finding out the policies to attract Portfolio Investment flows into Pakistan. Like Pakistan this study would also be of interest to policy makers in many developing economies.

  2. REVIEW OF LITERATURE

    Various studies have been offered on the factors of portfolio investment. Major portion of these studies has been conducted internationally. Keeping in view the importance of Portfolio Investment we present the review of significant studies.

    Statman (1987) examined that how many stocks make a diversified portfolio." Study showed that a well-diversified portfolio included at least 30 stocks and 40 stocks of randomly selected stocks for a borrowing investor and lending investors respectively. Study denied that benefits of diversification were attached with a portfolio of approximately 10 stocks.

    Trennepohl et al. (1988) provided empirical evidences about perfor- mance of insured portfolios constructed from listed put and call options their underlying stocks and treasury bills. Study found that insured portfolios represented the majority of main assets.

    Goldstein and Razin (2006) scrutinized an information-based trade off between foreign direct investment and Foreign Portfolio Investment. Results show that foreign direct investment ratio is larger than foreign portfolio investment in developing countries and same is lower in developed countries. Study used the probability criteria and risk measurements. Study has examined that investors with more liquidity shocks prefer foreign portfolio investment and investors with less liquidity shocks prefer foreign direct investment. Study has several results with empirical evidences. First developed countries attracted a larger share of foreign portfolio investment than developing countries. Second investors with high liquidity were attached with foreign portfolio investment and vice versa. Third developed economies with high levels of transparency have smaller differences between the withdrawal ratios of foreign portfolio investment and foreign direct investment.

    Lagoarde-Segot and Lucey (2007) analyzed portfolio diversification profits in seven MENA stock markets. Study used weekly data over the period 1998-2006. Data was obtained by the SandP/IFC. Conclusions highlighted the existence of diversification reimbursed in the considering region. The study found that minimum variance portfolio showed best performance. Study suggested that physically powerful and translucent economic and financial institutions are necessary for maintaining long-term portfolio returns.

    Goetzmann and Kumar (2008) examined the equity portfolio diversifi- cation. Study analyzed that US investors favoured less-diversified portfolios. Data has been taken from US discount brokerage house (DBH) from the time period 1991 to the end of 1996. Study focused on the improvement of diversification correlation of diversification with individual characteristics and on the relationship of portfolio diversification and performance. Study has concluded that majority of individuals are less-diversified and less- diversification is superior in retirement accounts. Study indicates that with respect to time diversification is improving. They found that variations in the correlation structure of the US equity market induced the improvement in diversification characteristics. They found that investors were less- diversified because they had better information and investors improved portfolio presentation by merely investing the available passive funds.

    Hasan and Nasir (2008) examined macroeconomic factors and equity prices with the help of ARDL approach. They analyzed the long-run causal association between Pakistani capital market and major economic variables. They used month wise data for the period 1998-2008. They used a set of...

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