Pakistan is a country that has been going through political instability and economic crisis for quite a long time. In this scenario we attempts to determine the effect of political risk on the stock market return in Pakistani stock market (KSE) along with the factors like exchange rate and call money rate. Using the data OF KSE INDEX, Positive and negative news items, Exchange rate and interest rate for the period from January 2008 to December 2010 on monthly basis and applying ARCH/GARCH models, we find that political risk has a significant effect that is; if there is political instability in the country it will affect the stock market return negatively. The factors: political risk and exchange rate individually affect the stock market return however their effect on each other is very low. The results suggest that an investor should avoid investing in stock market when there is a political turmoil and when the exchange rate and interest rate are showing irregular trends. Thus it is recommended when investors decide to put their money in stock market they should consider all the external and internal factors that can affect the stock return specially the political one.

BBA