International Journal of Basic & Applied Sciences IJBAS-IJENS Vol:09 No:09 6 1952091-IJBAS-IJENS © October 2009 IJENS I J E N S Modeling Uncerainty and Investment as Determinent Of Returns From Pakistani Insurance Companies Muhammad Ayub Siddiqui Assistant Professor Fast School Of Business, National University Of Computer and Emerging Sciences, AK Brohi Road, H-11/4 Islamabad-Pakistan mayubsid@yahoo.co.in , ayub.siddiqui@nu.edu.pk Phone: 0333-5153203 Abstract -- This paper tests pair-wise causal relationships between uncertainty, returns and investment using unbalanced panel data of the 13 insurance companies listed in the KSE for the period from 1996 to 2008. Volatility of returns from the daily stock was measured using the GARCH (p, q) for appropriate values of p and q. The study applied panel data models in the lines of common constants, fixed effects and random effects in order explore effects of uncertainty and investment on returns. The results show significant positive effect of uncertainty on the returns from investment. This subsequently recommends that investment under volatile conditions might prove a blessing for the investors of the insurance stocks. These findings are contradictory to the results of some of the previous studies. For most of the stocks, hypothesis of “investment (I) does not Granger cause uncertainty (H)” or “uncertainty (H) does not Granger cause investment (I)” could not be rejected. The study finds that change in returns from securities definitely brings about changes in the risk and uncertainty. JEL classification: C1, C13, G2 Index Term— Investment; Stock market volatility; Uncertainty, Returns, Insurance, KSE, Pakistan. I. INTRODUCTION Risk-return relationship is of central importance in finance theory. In Pakistan financial sector has shown a significant growth during the last 8 years. This remarkable growth can be attributed to growing privatization of financial institutions, policy of financial liberalization, and thereby creating an environment of competition in the financial market. Financial sector of the country crossed the highest growth of 30 per cent in the 2004-05 but could not sustain subsequently and ultimately declined to the growth rate of 18.2 percent in 2006- 07. Financial institutions including insurance companies listed in the Karachi Stock Exchange (KSE) can be termed as the best performing stocks, among all the sectors, with the highest average market capitalization (AMC) of Rs.1341.8b and growth of market capitalization to the tune of 87.7 percent, during the 2006-071. In order to cover credit risk, development of insurance business was a need of the time and requirement of the financing agencies in the wake of growing consumer financing by the banks and other financial institutions. In the event of mandatory requirement of the financing institutions, insurance business grew significantly and had vivid impact on the business of their stocks in the KSE. Studies failed to determine with consensus unidirectional causal relationship between uncertainty and returns, investment and returns and uncertainty and capitalization2. Empirical approach of my paper is different from other studies which attempt to rely on micro-data in order for exploring the effects of uncertainty on investment This paper, at the first stage, investigates pair-wise relationship between investment, uncertainty and returns from the stocks of insurance companies using Engel-Granger causality tests. No study in Pakistan so far has been conducted employing advanced econometric techniques in this area to determine the causal relationship of such important financial variables. At the second stage this study employs Panel Data methodologies. In the panel data models it estimates common constants, fixed effects and random effects assuming returns from these securities as function of uncertainty and investment. These are the most recent and efficient analytical methods. The data which ranges from 1996 to 2008 is imbalanced on account of different history and life of listing of various insurance companies. Initially EG causality tests determine the pair-wise direction of relationship between uncertainty, investment and returns. This paper may be considered as an academic contribution in the literature related to finance. Hence it identifies the issue of measuring uncertainty to analysts and researchers who can investigate and explore various causal relations among the financial variables by employing parametric and nonparametric statistical methods with reference to Pakistani Financial Sector.