The Karachi Stock Exchange (KSE100) lost 525 points (3.2 per cent decline) Tuesday after the news of the Supreme Court ordering the arrest of the Prime Minister flashed across news channels. The dubiously timed Supreme Court’s order, whose particulars are now in question, further fueled the uncertainty in the federal capital Islamabad where Dr. Tahir-ul-Qadri had staged a sit-in along with thousands of his followers.

Dr. Qadri and the Supreme Court have targeted the government at the same time, causing the uncertainty to reign supreme in the political and financial spheres of the country. The 2.5 per cent drop on January 2nd and the 3.2 per cent decline on January 15 show the bears scaling bourse’s walls as investors abandon the market in a hurry.  Dr. Qadri’s long march, which has turned into a short stay, has also caused suspension of business activity in Islamabad. The Federal Board of revenue estimates a daily loss of one billion rupees from the suspension of commerce in Islamabad alone.

Markets hate uncertainty of all types, particularly political chaos, which creates uncertainty about government’s longevity, and in the case of Pakistan such chaos is accompanied by extreme violence and destruction.

Research in stock market performance has revealed that markets react sharply to both good and bad news. However, the impact of bad news is often more pronounced than that of the good news. Helinä Laakkonen and Markku Lanne researched the impact of good or bad news on the exchange rate between the US dollar and Euro. They found that bad news often increased volatility more so than good news.  Another interesting finding was that the adverse impact of bad news was more severe during good economic times than in bad economic times. At the same time, the impact of good news did not differ between good and bad economic times.

In a recent paper, Muhammad Tahir Suleman reported his findings about the impact of political news on the Karachi Stock Exchange (KSE100 Index) returns. He found that good political news had a positive impact on stock returns and at the same time it reduced volatility. Bad news, on the other hand, decreased returns and increased volatility.

If one were to agree with the arguments made in the academic and professional literature that good news generally has a positive impact on returns and the bad news exerts a negative impact, one then wonders what positive news caused the 49 per cent increase in KSE100 Index during 2012. While the country limped from one crisis to another, the stock market continued its upward climb.  Last year witnessed the tug-of-war between the government and the Supreme Court that ended with the court ousting Prime Minister Yousaf Raza Gilani in June. KSE 100 reacted at the news of the prime minister’s dismissal with a decline of mere 71 points. However, in a short span of eight days the stock market recovered all losses since the day the prime minister was sacked.

It is rather interesting to note that the volatility in returns declined after the departure of Prime Minister Gilani (see the graph below). During late June and late December 2012, the KSE100 Index reveals significantly less volatility than the one observed for earlier periods. This again is an interesting trend because the first few months of Prime Minister Raja Pervez Ashraf’s tenure were spent playing hide-and-seek with the Supreme Court over the draft of the letter to be sent to the Swiss Magistrate to re-open cases against President Asif Zardari. Those uncertain times are not reflected in high or low stock returns (in percentage terms).