The Effect of Political Events on Stock Market Performance and Their Spillover Impact on South Asian Economies: Evidence from Pakistan

Abstract

Background: There is broad consensus in the financial literature that political events play a crucial role in explaining stock market behavior, especially in emerging markets with weak institutions where investors are more sensitive to the political environment. In South Asia, Pakistan’s political sector has for long been influencing the local financial markets and its impacts may have spread to some other regional countries due to close economic and financial linkages.

Aim: This paper examines the influence of political incidents on stock market returns of Pakistan and their spillover impacts to leading South Asian nations: India, Bangladesh, and Sri Lanka.

Method: Utilizing the daily stock index returns over 2,005{2024, the paper applies event study based methodology to record ab-normal returns around important political events like elections, regime changes and policy reforms. Volatility dynamics are studied using GARCH models while Diebold–Yilmaz spillover indices and wavelet coherence methodology are adopted to capture cross-market contagion.

Results: The results suggest that political events exert statistically meaningful negative influence on stock returns in Pakistan and subsequent volatility clustering is higher around the date of uncertainty. Pakistan is found to be the main spreader of shocks between markets in the region, especially with India and Bangladesh, pointing out a sizeable financial market interdependence. The short-run contagion effect is most severe in that it reflects the panic of investors and speculative trading, while long-run influences are relatively stable. Policy changes, however, receive only weak significant positive feedback implying an incomplete investor confidence on stabilization based policy measures.

Conclusion: The domestic stock prices in Pakistan are significantly influenced by political events and disseminate volatility to those of other South Asian countries. Reinforcing governance structures and regional financial co-operation is also needed to reduce the impact of political risk on stability.