World Applied Sciences Journal 19 (11): 1575-1584, 2012 ISSN 1818-4952 © IDOSI Publications, 2012 DOI: 10.5829/idosi.wasj.2012.19.11.2611 Corresponding Author: Ahmad Raza Bilal, Faculty of Management and Human Resource Development, Universiti Teknologi Malaysia, Johor Bahru, Malaysia. 1575 How Terrorism and Macroeconomic Factors Impact on Returns: A Case Study of Karachi Stock Exchange Ahmad Raza Bilal, Noraini Bt. Abu Talib, Inam Ul Haq, Mohd Noor Azli Ali Khan and Talat Islam Faculty of Management and Human Resource Development, Universiti Teknologi Malaysia, Johor Bahru, Malaysia Abstract: Despite limitation of ‘War on Terror’ in specific Asian countries, global economies are facing serious threats in their capital markets. As a front line state in War on Terror, Pakistan is facing economic instability and disquieting consequences. Recent emergence of religious, sectarian and politically induced terrorist factions has attracted dramatic focus of media, serious damages to public and private assets and unavoidably affected global equity markets. Due to central location of affected areas, equity markets of Pakistan are highly pretentious by consequences of War on Terror. This study examines the relationship between Terrorism and Macroeconomic factors (Interest Rate and Inflation) on Karachi Stock Exchange (KSE-100 Index) using daily basis data for Terrorism and monthly basis data for Macro-economic Factors from 1st July 2005 to 31st June 2010. Various statistical techniques are used include unit root Augmented Dickey Fuller test, Phillip Perron, Johansen's co-integration, Granger's causality test, ARCH, GARCH and GARCH-EVT. Findings of the study revealed co-integration between macroeconomic factors and KSE stock returns which demonstrate that largest equity market of Pakistan KSE-100 Index have negative relationship with Terrorism and causal relationship with interest rate; whereas, no relationship is found with inflation. Outcome of the study explored Cointegration and a long-term relationship among study variables. Key words: Terrorism Macro-economic Factors Interest Rate Inflation Karachi Stock Exchange Pakistan Cointegration INTRODUCTION international economies along with significant impact on Terrorism can be defined as “the premeditated use, or picking up to the moguls and hazard supervisors threat of use, of extra normal violence to obtain a political regarding the exceptional nature and false notion of such objective through intimidation or fear directed at a large occasions. Firstly, the starting business effect from dread audience” [1]. Researchers are of the view that terrorism ambushes is possible to be overcompensated and to negatively impact on the economy in many ways, e.g. it unwind over resulting days. Secondly, once the starting can impact on the financial system or international trade. frenzy moves, speculators take a more discerning check Investment and international trade are highly correlated out the medium-term financial effect. Thirdly, the micro with each other and can be exploited from instability of effect of ambushes can also create excruciating on organizational international trade. [2], is of the view that economies. Beyond any doubt, the degree to which terrorists can disturb the international trade mechanism ambushes have lifelong effects on business sectors, on which ultimately can disturb the whole world. Financial commercial ventures and nations relies on if they create markets have responded in an exceptionally significant gurus to re-assess their lifelong hazard evaluations way to September 11, 2001, the commandeered air [3, 4, 1]. transport ambushes in the United States. Continuous Concentrating on the effects of occasions around wave of terrorist attacks in Bali in 2002, the Madrid in 2004 Globe War II on costs of legislature bonds of some and London train bombings of 2005 greatly impact on nations bartered in Zurich and Sweden, separately [5]. the economy of Pakistan. Within story furnishes a base of