IMPACT OF INTEREST RATE ON STOCK MARKET

INTRODUCTION:
Stock market is the place which is used for buying and selling the securities. It is really
very important and plays a very important role in the development of the economy
especially in the financial sector. If someone wants to buy or sell any stock then he must
go to the stock market in order to do that. Stock market plays a very important role in
the financial market. There are different stock markets in Pakistan like PSE, LSE and
ISE. Stock market does not remain same always. The Pakistan stock exchange is
growing day by day but there comes some fluctuations too due to some political factors
or environment. KSE-100 and KSE-30 show the most 100 and 30 emerging companies
of the industry. Our study determines the impact of interest rate on stock market.
Quantitative research method is used by using the Microsoft Excel for the calculation.
Regression analysis is used to test the hypothesis. The basic purpose of this research
of this research is to show the relation between the interest rate and stock market.
Interest rate is actually the amount of interest due per period, as a proportion of the
amount lent, deposited or borrowed.

The total interest on an amount lent or borrowed depends on the principal sum, the
interest rate, the compounding frequency, and the length of time over which it is lent,
deposited or borrowed. The interest rate is given by the state bank of the country. The
major interest rate remains the same for all the banks. However, there comes a very
minor change in interest rate of all the banks. The leverage is given to banks by the
state bank of the country. There are different names of the interest rate like if we see
the interest rate form the borrower’s point of view, we can say that the borrower use it
as the cost of borrowing a money. If we see it from the lender’s point of view, we can
say that the lender use it as the rent of using his money.

Good investors always invest their money in that markets that are efficient. If the banks
offer high interest rate to the depositors, people move their money from stocks to the
banks. It will decrease the demand of the shares in the stock market and automatically it
will decrease the prices of the share. Gradually, if banks reduces the interest rate for the
depositors, people shift their money to stock market and demand of shares will increase
and price of the shares will also increase. So, theoretically, we can say that there is an
inverse relationship between the stock market and the interest rate or we can say that
interest rate has a negative impact on the stock market.
This study will analyze the impact of interest rate on stock market. Quantitative research
method is used for this purpose on monthly data from 2008-2018. This research will let
us know the relation and connection between the interest rate and the stock market.

This research paper is written to find the answers of the following questions: What is the
relation between the interest rate and stock market? What is the effect of both variables
on each other? Lastly what is the importance of both the variables i.e interest rate and
stock market.

LITERATURE REVIEW:
Salman Ahmed (2010) studied the relationship between interest rate and stock market
capitalization. He used the single-variate regression model where he found that
increase in KIBOR and SBP Repo rate increases the liquidity of banks and financial
institution which increase the investment in the stock market and due to which stock
market capitalization increase. So, results show that the interest rate has a positive
effect on stock market capitalization.

Prakash Kumar Shrestha investigated the influence of interest rate on the stock market
during inflation in Nepal. The Augmented Dickey-Fuller and Phillips Peron test used to
access this relationship. The conclusion came up with the findings that the high-interest
rate strongly affects the stock market because of invertors lessor their investment in the
stock market due to high stock prices.

Arif Hussain, Ahmed Bilal Hussain and Shahid Ali described the empirical study of stock
prices volatility on the bases of interest rate volatility in Pakistan Stock Exchange (PSX).
By the help of Auto Regression Conditional Heteroskedasticity (ARCH) and Generalized
Auto Regression Conditional Heteroskedasticity (GARCH) method they concluded that
Auto Regression Conditional Heteroskedasticity (ARCH) is statistically proved in
Pakistan Stock Exchange and short-term volatility has a positive association with the
overall volatility of stock returns.

Mrs Kumada PR and Mrs Kamala G consider both interest rate and stock prices and
analyzed their effect on eleven sectors of India. They applied Karl Pearson's Co-efficient
of correlation and Linear Regression method on the data which has been taken from the
National stock exchange and reserved bank of India for a 10-year period from 2005 to
2014. The result showed that six out of eleven sectors remarkably impacted by interest
rate.
Wensheng Kang, Ronald A. Ratti, and Kyung Hwan Yoon (2014) examined the relation
between stock return, stock market volatility and oil price shocks. They manipulate the
monthly data and found that Positive shock to global aggregate demand is associated
with negative effects on the covariances of return and volatility and also Positive shocks
to oil-market specific demand have a statistically significant negative effect on the return
and volatility covariance by realized-volatility, conditional-volatility, implied volatility
method.

To find a correlation between interest rate and stock prices Hamdan Ali also worked on
it. In his study he considered different other factors which had impact on stock market
and one of them is political performance which effect the economy and stock market of
country. We scrutinize his article and come to know that interest rate has negative
effect on stock market.

Discussion on the stochastic behavior of stock market returns, 3-month Treasury Bills
rate, lending rate and their cointegrating residuals remains unsettled. In 2017 Donald A.
Otieno, Rose W. Ngugi and Nelson H.W. Wawire appraised these variables through
ARFIMA-based Granger Causality model. They implement this model on monthly data
from first January 1993 to thirty-first December 2015. And results reveal that 3-month
treasury bills and lending rate negatively impact on stock market returns.

Different researchers concluded different studies and they tried to evaluate the link of
interest rate and stock market. Md. Mahmudul Alam and Md. Gazi Salah Uddin
investigated the data of Dhaka stock exchange from 1992 to 2004 and the outcome was
the negative connection between interest rate, stock prices, growth of interest rate and
growth of stock prices.

Researchers negotiated and they found that if Bangladesh controlled their interest rate
then investors attract towards their country market and in this way their market will
grow.

On the other hand, FOO ZOR THANG in 2009 survey showed that there is significant
correlation between Malaysia exchange rate and interest rate. Johansen Juselius (JJ)
cointegration test, Vector Error Correction Model (VECM) and Granger Causality test
were exercised on the data to search the impacts of long and short run, their research
helps the investors to make decisions and planning for investment portfolio.

Furthermore, not every research describes the negative relation between interest rate
and stock price. In Jordan, Husni Ali Khrawish , Walid Zakaria Siam and Mohammad
Jaradat narrated that interest rate and stock market were positively interdependent. As
Hamdan Ali stated in his article that political performance has great impact on stock
market, that’s why previous research shows the positive link.

The relation between stock market and interest rate movement has been the focus of
many amount of research from past many years. Some research showed positive
relation some presented the negative relation and some described that there is no
relation between stock prices, stock return, stock price index, exchange rate and
interest rates. In India, one of the researches on stock return and interest rate unveiled
that there is no interrelation between these variables.

METHODOLOGY:
The Data for this research will be gathered from different sources. The data for interest
rate will be collected from the website of State Bank Of Pakistan for the period of 2011
to 2019. Data for “Stock Price” will be taken from Pakistan Stock Exchange. The
purpose of this research is to narrate the impact of interest rate on the stock market by
using regression and correlation method.