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DIVIDEND POLICY AND STOCK PRICE VOLATILITY IN PAKISTAN Dr. Mohammed Nishat Professor and Chairman Department of Economics and Finance Institute of Business Administration University Road, Karachi email: [email protected] Phone: 111-422-422, Fax: 9243421 and Chaudhary Mohammad Irfan MPhil Student Applied Economics Research Centre University of Karachi email: [email protected] Abstract This paper attempts to determine the impact of dividend policy on stock price risk in Pakistan. A sample of 160 listed companies in Karachi Stock Exchange is examined for a period from 1981 to 2000. The empirical estimation is based on a cross-sectional regression analysis of the relationship between stock price volatility and dividend policy after controlling for firm size, earning volatility, leverage and asset growth. Both dividend policy measures (dividend yield and payout ratio) have significant impact on the share price volatility. The relationship is not reduced much even after controlling for the above mentioned factors. This suggests that dividend policy affects stock price volatility and it provides evidence supporting the arbitrage realization effect, duration effect and information effect in Pakistan. The responsiveness of the dividend yield to stock price volatility increased during reform period (1991-2000). Whereas payout ratio measure is having significant impact only at lower level of significance. In overall period the size and leverage have positive and significant impact on stock price volatility. The size effect is negative during pre reform period (1981-1990) but positive during reform period. The earning volatility impact is negative and significant only during reform period. Although the results are not robust enough as in the case of developed markets but are consistent with the behaviour of emerging markets. Key Words: share price volatility, Valuation theories JEL Classification: G10, G19
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DIVIDNED POLICY AND STOCK PRICE VOLATILITY IN PAKISTAN Mohammed Nishat Chaudhary Mohammad Irfan 1 1. INTRODUCTION Dividend policy remains a source of controversy despite years of theoretical and empirical research, including one aspect of dividend policy: the linkage between dividend policy and stock price risk (Allen and Rachim, 1996). Paying large dividends reduces risk and thus influence stock price (Gordon, 1963) and is a proxy for the future earnings (Baskin, 1989). A number of theoretical mechanisms have been suggested that cause dividend yield and payout ratios to vary inversely with common stock volatility. These are duration effect, rate of return effect, arbitrage pricing effect and information effect. Duration effect implies that high dividend yield provides more near term cash flow. If dividend policy is stable high dividend stocks will have a shorter duration. Gordon Growth Model can be used to predict that high-dividend will be less sensitive to fluctuations in discount rates and thus ought to display lower price volatility.
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