The Relationship between Interest Rate and Stock Market Index in Zambia –A Cointegration Analysis
Being familiar with the relationship between interest rates and the to figure out how to evaluate the impact of rate changes in stock prices. The Federal Reserve raises or lowers interest rates to fight inflation or make it easier for companies to The stock market doesn't generally like high interest rates. The Relationship Between Money Supply & Stock Prices. How do currency value and interest rates affect banks' stock prices? 1, Views · How do What is correlation between interest rates and stock share prices?.
Being familiar with the relationship between interest rates and the stock markets can help investors understand how changes might have an effect on their lives, and how to make better investment decisions. Short Term and Long Term Impact In the short term — The instant impact of a rise in interest rate is on companies with high debt in their balance sheet. The interest payment made by them rises which reduces their EPS. Thus there would be negative sentiments for such stock; resulting in a depleted stock price.
In the long term — High-interest rate would have a more sector-specific impact. The sectors which are most impacted by high-interest rate are the real estate, automobile, and all the capital-intensive industries. So, any investment in these sectors must be taken with a considerable amount of caution during the situation of high-interest rates.
So, definitely, the High-interest rate is not the best option for a country. When the interest rate is very low, you would be obviously saving less and consuming more. The fixed deposits are no longer attractive. This might leave the banks with much lower money to lend out to the borrowers, and their profit margins would also be affected by a lower interest rate.
- The Effect of Interest Rates on Stock Market
The government in such a scenario would certainly resort to the printing of currency to infuse more money in the economy. This would lead to an inflationary situation in the country.
At very low-interest rate the inflows are likely to be reduced. In the US, the Federal Reserve increases or decreases interest rates to fight inflation or ensure it is less difficult for companies to borrow money. Investors have to figure out how to evaluate the impact of rate changes in stock prices. Shares represent parts of a business and businesses are funded by loans. As a result, a rate rise will certainly itself decrease profitability by making their debt more expensive, cutting into their profits.
They will spend more to service their debt, which means that the capital available for investment decreases. So in whole, a rate rise will probably generally signify businesses are less profitable due to increased borrowing rates.
Repo rate is the rate at which RBI lends to its clients generally against government securities. Reduction in repo rate helps the commercial banks to get money at a cheaper rate and increase in repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.
Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The two variables show a negative relation as they moved in the opposite direction.
Graphs showing the Stock Index and Interest rates Source: Bank of Zambia and Lusaka Securities Exchange 4. Econometric Modelling This study used Johansen cointegration test methodology to estimate the long run relationship and Vector Auto Regression VAR to estimate the short run relationship between the Interest rates and the stock price index.
Before the estimates were done some diagnostic tests were performed. The first was the test for of normality of the dependent variable stock price index. The normality test was satisfied as the Jarque-Bera statist of 5. The result in Table 1 below shows that both the LuSe price index and the interest rate were stationery after first differencing.
This can be observed from the t-values of 4. Long Run Cointegration Test Since the variables were stationary after the first difference, a cointegration test was done in order to estimate the long run relationship. Cointegration Test Analysis results The Johansson cointegration test results in table 2 above shows that there is a long run relationship between LuSE Price Index and Interest rates as the trace statist value of Hence the null hypothesis of no long run relationship between interest rates and the LuSE stock Price index was rejected.
Auto Regression Distribution Lag Bound Tests Having established that the variables had a long run relationship, there was need to estimate the impact, hence Auto Regression distribution lag bound tests was done to establish the long run coefficients. Table 3 shows the results for the Auto Regression distribution lag bound tests.
Auto Regression distribution lag bound tests From the results, the estimated coefficient for Interest is negative and statistically significant. This indicates that increase in interest has a negative effect on the stock price index.
This is in line with the conventional economic reasoning, when the interest rate is high, investors will shift their money from higher risk instrument which is the stock market to save or fixed deposit accounts where they can earn higher interest. On the other hand, when the interest rate is too low, investors will move the money out to invest in the stock market in the hope of getting a higher return.
Therefore, the following regression model presented below was estimated. This was done after satisfying residual diagnostic test like heteroscedasticity, Serial correlation and normality. Furthermore, a unit increase in interest rate will lead to a decrease of 0. Table 4 shows the results, the coefficient of a constant is 1.
Relationship between Interest Rate & Stock Market – Ontrust Capital
This shows that interest rate has a short run impact on the stock index. Hence the null hypothesis of no shot run relationship between interest rates and the LuSe Stock Price index was rejected. Similar results were observed Alam and Uddin, ; Thang, ; Nordin et al, Conclusions This study investigated the relationship between Interest rates and the Lusaka Securities and Exchange price index.
The cointegration analysis shows the presence of the long run relationships.
The Error Correction Model ECM also confirms the existence of short run relationships between the stock price index and Interest rates. The policy implication of this study is that, the central bank should control the interest rate by reducing it. Since this is the rate at which it lends to commercial banks it sets the floor for the interest rate regime in the money market, hence reducing it will have a spillover effect on the reduction of lending rates.
The Effect of Interest Rates on Stock Market | Finance - Zacks
Furthermore the central bank should consider reducing the Reserve requirement of the deposit that commercial banks should deposit with the central bank. This Fractional reserve limits the amount of loans banks can make to the domestic economy and thus limit the supply of money, so if this reserve is reduced it will increase the money supply hence reducing lending interest rates.
If the interest rate is considerably controlled by reducing, it will be of great benefit to the stock exchange market in Zambia as this will act as a demand pull way of more investors from investing in debt to investing in stocks. References  Alam, M. Relationship between interest rate and stock price: Impact of interest rate on stock Market; Evidence from Pakistani market.
Monetary policy dynamics and the stock market movements: Journal of Applied Economic Sciences, 10 8 Impact of macroeconomic variables on stock markets: Evidence from emerging markets. International Journal of Economics and Finance, 8 1 A Comparison between China and US.
Relationship between Interest Rate & Stock Market
The relationship between share prices and interest rates: School of business, University of Nairobi. Evidence from Zimbabwe International Journal of Economics and Financial Issues, 5 3. International Journal of Economic Research.
Effects of macroeconomic variables on stock returns in the East African community stock exchange market. International Journal of Education and Research, 3 10 Journal of Financial Risk Management, 6, A generalized autoregressive conditional heteroskedasticity model of the impact of macroeconomic factors on stock returns: International Journal of Financial Research, 4 4 Malaysian Management Journal, 18, 39— The relationship between macroeconomic variables and stock market index in Nigeria. Journal of Economics, 3 1 ,