Is KSE 100 Index Inflated?

This research intends to identify structural weaknesses in the Karachi Stock Exchange 100 Index (KSE 100 Index). The present methodology of KSE 100 Index and its return is compared against other widely used methodologies like Price Weighted Index and Equal Weighted Index. Data analysis of KSE 100 Index companies used in these indices indicates inflated returns through presently used market capitalization method. This inherent flaw of inflated results is magnified due to concentration of market capitalization of Index into few stocks and limited sectors of economy. The market capitalization of the stocks also impacts the return of the index as indicated by the positive correlation values. The relationship between the GDP growth of Pakistan and KSE 100 Index is not as strong as witnessed in major global indices. Index is not representing the economy sectors according to their percentage in GDP. Thus, the analysis of KSE 100 Index reveals serious structural flaws in true return of the companies in the Index and it is unable to represent the economy. These conclusions pose a serious threat to the use of KSE 100 Index as a benchmark for market return in Capital Asset Pricing Model (CAPM) in fair value calculation of Pakistani Stocks. This also creates doubt about the forecasting ability of KSE 100 Index about the GDP growth rate of Pakistan.