An important topic of finance is to study the expected asset return having systematic risk involved through the macroeconomic variables. The theory of portfolio by Markowitz (1952) brought a tremendous change in the field of financial economics. This theory discussed the choices/ alternate investment decisions of the investor and the associated risk elements. The second stage was to set market equilibrium status and prices of the assets containing risk. In this regard the famous scholar Sharpe (1964) presented the CAPM stands for Capital Asset Pricing Model and that model was further modified by (Linter 1965, Mossin 1966). Association of systematic risk with security is shown through variation in the asset with respect to market portfolio in the CAPM. However, it was criticized by various researchers (Harrington 1987, Fama and French 1992). Ross (1976) presented a more generalized form of the CAMP known as the Arbitrage Pricing Theory (APT) based on a few restraining and realistic assumptions. The APT propagates that expected rate of return on an asset relies on the variation in the macroeconomic factors containing systematic risks that cannot be fully controlled. On other hand, unsystematic risk related to firm can be controlled. The CAPM is a special case of the APT. Within the framework of APT several multifactor models have been used employing macroeconomic variables. Findings of these studies revealed that several macroeconomics indicators affected the aggregate stock market index.

After its establishment in 1947, the equity market of Karachi started its operation with KSE 50 index. Being a benchmark KSE 100 index represents the maximum market capitalization of the enlisted companies of the Stock Exchange. In the year 1992 Security Exchange Commission of Pakistan was established in order to ensure liberalization, facilitation and modernization of the operations of the stock market. Companies enlisted with the equity market have been divided in 36 categories. Out of these, 32 companies fully contributes to the capitalization value of the market. Karachi stock market has been through many good and bad times. It has been declared among the best markets of the world several times. KSE remained the biggest stock market until in 2016 its merge with Lahore and Islamabad Stock Exchange (ISE). Now it is known as the Pakistan Stock Exchange (PSX) with KSE 100 index still the key index for measuring the stock market performance.

This paper aims to investigate that how macroeconomic variables impact the aggregate stock return of the Pakistan Stock Market i.e. KSE 100 index within the frame of the APT by analyzing the relationship in short and long run. It applied econometric models such as the co-integration technique and the VECM for this purpose.

The literature regarding asset pricing can be traced out from research contributions of several scholars, in which Sharpe (1964), then Lintner (1965) and finally Mossin (1966) presented the asset pricing model like CAMP for establishing market equilibrium and pricing of the asset containing risk. Later on Rolls (1976) presented the APT which was an alternative to the model of CAPM. Later Roll and Ross (1980) and then Huberman (1982) its empirical form gradually and systematically by Roll and Ross (1980) and Huberman (1982).

The APT was examined empirically by Roll and Ross (1980) by applying four factors loading of macroeconomic factors in the context of the US economy. Findings of the study supported this theory and concluded that stock return relies on these factors. It was modified by Chamberlain and Rothschild (1982) who focused on determining the estimating arrangement of the variables. Their findings suggested that principle component could be applied due to approximate unique factor structure result when there exist only k unbounded Eigen values for covariance matrix. The APT model of Ross was criticized by Humberlain (1982) who concluded that his APT is a bit complicated as it cannot clearly define arbitrage and that the condition for the presence of no arbitrage is not compulsory. He therefore defined the arbitrage more clearly and the insight of the APT was made formal. The impact of asset pricing was analyzed by Chen, Roll et al. (1986) who employed the equity market returns with macroeconomic variables as sources of systematic risk. Late the APT was applied by several researchers like Chen et al. (1980), Fama (1990), Ferson and Harvey (1991) in their studies significant influence has been found between equity return and macroeconomic factors possessing considerable capacity of explanation. By employing VECM and test of Granger Causality Abdullah and Hayworth (1993) analyzed the fluctuations occur in the US stock market i.e. S&P 500 index through variation in the macroeconomic forces such as inflation, trade deficit, industrial production, interest rate, budget deficit and money supply. Empirical results obtained implied that all of the variables Granger cause the equity prices excluding industrial production. The long run association between macroeconomic factors and equity market returns was examined by Cheung and Ng (1998) in the context of US, German, Japanese, Canadian and Italian economies. They employed variables of equity market indices with real consumption, real output, real oil prices, real money supply, real GNP of the respective economies. Findings of the revealed significant linkages among the overall variables ad equity market indices.

A significant association between economic activity and equity market was observed through VECM by Chaudhuri and Smiles (2004)while examining macroeconomic factors like real GNP, real oil prices, real money supply and real private consumption with equity market return for the economy of Australia. Association in the long and short haul between variables like oil prices and money supply with US Stock market index like S&P 500 index was investigated by (Rahman 2008). Relationship in the short run only was observed from empirical findings of the study. The descriptive capacity of the macroeconomic variables with respect to stock market developments for developed economies of the world was shown through the studies discussed above. However, research gap still exists in literature regarding analyzing the effect of potential macroeconomic factors with respect to stock market developments in the under developed economies. The test of APT in the emerging economies is of more importance as changes in the information and market factors are more frequent as compared to developed economies. Thus the results are also not the same in such research studies. Some of the research for the less developed economies is here under. Ibrahim and Musah (2014) examined the interlinks between stock index of Kuala Lumpur stock exchange and variables like money supply, CPI, credit aggregate and reserves, exchange rate and real production index . He applied the statistical techniques of co-integration and multivariate Granger Causality. He observed long term relationship for variables of credit aggregate and reserves and CPI. Impact of Turkish Stock market with respect to factors like foreign exchange rate, money supply and interest rate was examined by Muradoglu, Taskin et al. (2000) as Co-integration technique applied by him revealed that results were not supportive due to the fact of frequent variations in the market participants.

Gunasekarage, Pisedtasalasai et al. (2004)attempted to exam the variables effect i.e. CPI, money supply and rate of T bill on the equity index market of Colombo, Sri Lanka. He observed significant association (i.e. short & long haul) based on results of the research word.

Adam and Tweneboah (2009)used quarterly time series data to examine the short and long haul for the macroeconomic forces and equity market return in Ghana. Empirical results obtained showed a considerable long haul between inflation and equity return. However, based on results of variance decomposition it was asserted that inflation acted as a hurdle to stock return for attaining a positive effect for variables like exchange rate, FDI and interest rate.

Stock market Performance of Nigeria while restraining in the scaffold of APT by using OLS method was studied by Izedonmi and Abdullahi (2011)who used monthly time series data from 2000-2004 for variables like market capitalization value, inflation and exchange rate. The influence of these variables on performance of the stock market of Nigeria was denied on the basis of the outcome of the statistical analysis.

For the Indian economy, Dasgupta (2012)investigated the linkage among equity market index and set of macroeconomic indicators such as foreign exchange rate, rate of inflation, interest rate ad GDP. Empirical results obtained revealed the presence of long run association conveying that informational inefficiency prevails in the equity market of India. Further, no causality was documented for these variables.

Ahmad and Zhao et al. (2016) applied Johensen Cointegration analysis for investigating the association between monthly inflation rate ad monthly closing values of Dhaka Stock Exchange for the period of 09:2004 to 07:2014. At 5% level of significance a Cointegration equation is shown signifying long term relation between these variables. Further a short term association between the two variables was also noticed.

Chauque and Rayappan (2018)examined the influence of inflation and exchange rate factors on returns of Malaysian equity market by applying the ADF test, Ganger Causality test and OLS method. Empirical findings revealed a negative effect of inflation and exchange rate on the performance of equity Exchange of Kuala Lumpur. Further, Granger causality test showed the presence of unidirectional linkage from stock return to inflation implying that previous values of the stock market returns could be used for estimating future inflation levels in Malaysia.

Literature pertaining to investigation of association between macroeconomic forces and equity market can be categorized into 3 classes. Important or considerable association for the macroeconomic forces with returns of the equity market was revealed from their studies (Maysami, Loo et al. 2004, Kyereboah‐Coleman and Agyire‐Tettey 2008, Buyuksalvarci 2010, Ray 2012, Farhi, Gopinath et al. 2014). On the other hand, insignificant association was demonstrated from other studies (Mahdian and Ravikumar). Thirdly mixed results carrying both significant and insignificant factors were documented some studies (Kurihara, 2006; Pal & Mittal, 2011; Ullah et al., 2014).

1. There is a statistically significant effect of macroeconomics factors on equity returns

2. Karachi Stock market is semi strong efficient

The study is deductive in nature as the quantitative data has been examined by means of statistical methods in order to check the study's assumptions. Published data of time series nature has been selected in this study. KSE100 index has been used as proxy and for macroeconomic factors inflation (CPI), exchange rate (KIBOR), interest rate (10 years bond yield), GDP, unemployment rate, Labor force cost and S&P 500 index have been selected. The basic purpose of the study has been achieved through econometric tests like unit root test i.e. the ADF analysis.

The following tests with respective tables below have been mentioned with their specific purpose or task.

The characteristic of time series data pertaining to the variables of economics carries with itself problem of unit root. In other words, a researcher first checks for stationary of the data which is time series natured. In order to solve this issue researcher mostly apply ADF test for data sample. Unit Root postulates in the Null hypothesis, whereas an alternate postulate negates it. Always the value of ADF test is illustrated negatively. Chances of turning down the null hypothesis raise if the value of ADF obtains tends to move more towards negative.

The test statistics and critical values are the two criteria for the making result decision in ADF test are checking. Here at 5% level of significance-2.881 is critical value. Table shows the test statistics value. Then the Philips-perron test value. So it can be concluded that KSE 100 index and other variables are integrated of order 1 or I (1). Initially other variables were not stationary and got stationary at first order after taking the first difference.

For the selection of lag, Varsoc command is applied. It mainly helps in setting out the optimal lag level that is going to be applied in the test of Co-integration. Obtained empirical findings of the Varsoc test has been illustrated from the table below in which 236 observations have been used.

Before conducting the co-integration technique, the data in hand which is of time series in nature is it is ensured to be of 1st order integration. This test recognizes the equations that are co-integrating. Estimation of the vectors of co-integration is done. Now if co-integration is found then it means that in the long run, variables of the study are at equilibrium. Linear combination of the variables can be observed if each are I(1).

Based on the approach of Johensen & Juselius (1990) the proposed equation is as follow:

Vecrank KSE 100 Index GDP Eco growth Exchange rate unemployment rate Labor force inflation trend(constant) lags(1) Cointegration

Johenson test for cointegration

Nos. of observation: 239

Sample: 2-240

Vector error correction model

Sample:2-240

No. of obs.= 239

AIC = 40.26247

Log likelihood =-4785.365

HQIC = 40.41487

Det (Sigma-ml) = 1990717

SBIC = 40.64066

Cointegration Equation

Johanson Normalization restriction Imposed

Identification

Beta is exactly identified

First hypothesis of the paper is whether the aggregate equity return is determined through variation in macro-economic factors like GDP, Exchange rate, Interest rate, Cost of Labor Force, Unemployment rate, Inflation and equity market of the US or not? These macroeconomic forces really affect the return of an equity market. Macroeconomic variables including labor force cost, economic growth, exchange rate, and inflation are found to be significant variation with stock return while the rest of the variable such as unemployment rate equity market and GDP founds to be insignificant variation.

Second hypothesis of the paper was to investigate that Pakistan equity market reflects semi strong form of the EMH or not. Findings of the study reveal unclear results and question the validity of the APT and said EMH form. The APT and semi strong form test of the EMH are conducted together through joint hypothesis testing according to efficiency of a market cannot be eliminated. As a result, we can conclude that Pakistan Equity market does not reflect the semi strong form of efficiency.