The causal relationship between stock price and interest rates

Abstract

The relationship between the movements of interest rates and stock prices has been the subject of much speculation and empirical investigation. This is understandable, given the important role they play in the economic development of a country. The relationship between the two is of interest not only to economic theorists but also to investors who have to grapple with issues regarding asset allocation and market timing. This study examines the relationship between stock prices and interest rates and attempt to determine if there’s any causal link between the two. Interest rate is represented by the weighted average lending rate of commercial banks in Kenya and stock prices are proxied by the NSE 20 share index. Secondary data, in the form of weekly observations for the period January 2004 to December 2013 is utilized. Time series analysis and the Granger causality test is employed to examine the relationship. The results indicate that there is no significant causal relationship between interest rate and share price. CHAPTER ONE INTRODUCTION 1.1 Background The relationship between the movements of interest rates and stock prices has been the subject of much speculation and empirical investigation. The relationship between the two is of interest not only to economic theorists but also to investors who have to grapple with issues regarding asset allocation and market timing. The fundamental principle for the relatio