Abstract
This study aims at testing the validity of arbitrage pricing theory in Pakistani economy using macroeconomic variables (inflation, exchange rate, money supply (M1) and oil prices). Exchange rate is taken as Pak Rupee against US Dollar. Convenience sampling technique is used to locate the sample and monthly returns for 5 years (2004-2008) for 26 companies listed on Karachi Stock Exchange constitute the sample for this study. Regression is run for all 26 companies individually using stock return as dependent variable and all the macroeconomic factors as independent variables. This yielded the sensitivity of stock prices to each macroeconomic variable (beta) which were in turn used to calculate the projected values for all companies in the sample. T-test is used to compare the actual and projected stock returns. The results show no significant difference between two value sets thereby concluding that arbitrage pricing theory is valid for predicting future stock returns.