| Abstract | This study aims at providing an economic analysis of Pakistan's capital market, as opposed to a purely financial and operational approach. The purpose of this study is to present a critique on the structure and the role of market participants, in order to understand the importance of developing equity markets for increased flow of investment in an economy. The study explores not only the development of Pakistan's equity market, but its current state, constraints to further development, and future prospects are also looked into. The significance of a vibrant and well developed bond market is also defined. In order to grasp the meaning of the word 'efficiency' in relation to an equity market, a theoretical definition and discussion are also presented. The conditions necessary for the existence of an efficient market, and their application in Pakistan is also highlighted. The lack of liquidity and depth in Pakistan's equity market, along with its implications regarding the manipulation of share prices is also discussed. In order to familiarize with the trading operations, different modes and forms of trading taking place at KSE are documented. At the same time the role of various entities, such as brokers, individuals, foreign and domestic institutional investors, and the regulatory bodies is also presented. A comparison of Karachi Stock Exchange with other emerging markets on the basis of PIE Ratios, market capitalization, ratio of market capitalization to GDP, etc., identifies KSE as a cheap market. A PIE ratio that is low in relation to other emerging markets and most neighboring countries is cited as a major reason for the preference of foreign investors and fund managers to invest in Pakistan. As far as the development of a bond market is concerned, problems regarding the infrastructural elements, the existence of a secondary market, and the role of a credit rating agency are highlighted. Current state of the Pakistani bond market along with the available instruments and the factors hindering the development of a corporate debt market are also pointed out. The recommendations provided focus on policy incentives, regulation, and interest rate liberalization. Although, a number of tax incentives have been provided, there is need for more compatible and long-term planning so that the incentives offered are able to cause a favorable shift in investor behavior and preference. The study deals with some broad policies and issues that require the attention of Pakistan's regulatory bodies to enhance and sustain interest in the capital market. Future development plans of the KSE include the introduction of new forms of trading and instruments, development of a well organized secondary market, and the increased role of existing as well as new market participants. It is hoped that this report is able to highlight most areas of concern from an investor's point of view and the role of market participants, and comes up with relevant recommendations. |