relationship between share prices and interest rates: evidence from Kenya

Abstract

The changes in interest rates do have a diverse effect across the economic spectrum in any country. The sectoral and economy wide effects of interest rates may ultimately be reflected in the stock prices. Policy makers, scholars, economists, business owners, regulators and the general Kenyan public are grappling with figuring out the relationship of stock prices and interest rates. The objective of this research is to examine how changes in interest rates (represented by the weighted average lending rate by commercial banks in Kenya) and stock prices (proxied by the NSE 20 share index) are related to each other for Kenya over the period October 2002-September 2012. The research used Toda and Yamamoto (1995) method to determine the relationship between stock prices and interest rates. This method is applicable “whether the Vector Auto Regression (VAR) may be stationary (around a deterministic trend), integrated of an arbitrary order, or cointegrated of an arbitrary order” (Toda, Yamamoto, 1995, pp.227). The results therefore indicated that there is no significant causal relationship between interest rate and share price. As regards the sign of causality, negative causality exists in both directions.