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

The objective of the study is to examine possible presence ofnonlinear speculative bubbles in the Karachi Stock Exchange (KSE).Bubbles are argued to exist when there are substantial deviations ofmarket value from the estimated fundamental values. We estimate a seriesof fundamental values from a four variable Vector Autoregression Model(VAR) using the main KSE100 index along with measures of world stockprices, the Pakistani exchange rate, and the Pakistani short-terminterest rate. Residuals of this estimated fundamental time series arethen tested for possible speculative deviations using a Hamilton regimeswitching test and a rescaled range Hurst coefficient test, with afurther test for nonlinearity beyond the ARCH effects using the BDSstatistic. For all of these, we reject the null hypotheses of theabsence of speculative bubbles and nonlinearities beyond ARCH in theseseries. While these results suggest the possible presence of suchbubbles, we note methodological limits on proving that due to theproblem of mis-specified fundamentals. We further discuss somecharacteristics of the regulatory environment that may make itespecially susceptible to such phenomena and may be considered by thepolicy-makers for the attenuation of speculative and manipulativebehaviour. Keywords: Bubble, Pakistan, Stock Market, Regime Switching,Rescaled Range Analysis, Nonlinearity