Research Proposal
Master of Science, MSc
Interest Rates and its Impact on the Stock Market: The Ghana Experience
Benjamin Walali Amewornuble
[email protected] / [email protected]
Background to the Study
From the establishment of the first stock exchange, the Amsterdam Stock Exchange in 1602 by the Dutch East India Company, to date stock exchanges keeps playing significant roles in every economy (cite). Till date, stock markets have remained as an integral part of the growth process many developed and even developing economies. A developed, dynamic and vibrant stock market contributes significantly to economic growth and development. The stock market is an aspect of the capital market at large that provides an avenue for raising the long-term financing needs of businesses. This increasing importance of stock market has resulted in many theories being developed to explain its nexus with economic growth (Ananwude and Osakwe, 2017).
As a major aspect of the financial sector, stock market plays a major role in financial deepening and development of an economy. In principle, the stock market is expected to promote economic growth by providing a boost to both domestic and foreign investment (Singh, 1997). The stock market helps corporations or companies to raise funds to expand their activities in a cost effective way. The stock market has remained a major source of capital for most companies, either through initial public offer (IPO) or rights and bonus issues. As noted by Myers (1984), most companies have you used the funds raised from this market to expand their business operations over time and adjust their capital structure into an efficient form.
On the importance of stock markets, Levine (1991) points out the two key arguments: stock exchanges speed up the economic growth in two ways. The first is by making property changes possible in the companies, whilst not affecting their productive process; the second is by offering higher possibilities of portfolio diversification to the agents.

On this subject, the study of Levine and Zervos (1996) again suggests that the level of stock exchange development is positively associated to economic development. Similar works by the same authors (1998a) pointed out that the capacity of transmitting property in advanced economies eases the efficient allocation of resources, the capital formation and the economic growth.
Also Demirgüc-Kunt and Maksimovic (1998) found a relationship between the rhythm of economic growth and the stock market activity in the field of transmission of securities (secondary market) more than in funds channelling (new emissions or primary market). The same authors, in a study carried out in 1996, with a sample of 30 countries for the 1980-1991 period, drew the following conclusions: stock market advances in emerging countries do not imply a decrease of banking business in the financing of business, but, on the contrary, lead to higher activity in banking systems. Banks and markets do not appear, therefore, as alternative or rival institutions, but are complementary to each other, reinforcing the whole activity of the financial system.

Yartey and Adjasi (2007) studies on the stock markets in sub-Saharan Africa concluded that, stock markets remained the important source of finance for funding growth of large corporations in some African countries. Thus, a performing stock market is very key to economic growth. Notwithstanding, stock markets performance depends on certain macroeconomic variables. These includes GDP, price level, exchange rate, inflation and interest rate (Chen, Roll and Ross, 1986; Gupta and Modise 2013; Ikoku and Huseinii, 2013). In addition, as indicated by Breeden (1979), Campbell and Cochrane (1999) and Merton (1973), macro variables are key state variables in intertemporal asset-pricing models and represent priced factors in Arbitrage Pricing Theory (Ross, 1976), besides playing a role in affecting future investment opportunities and consumption.
The interrelatedness of the operations of stock markets to other activities makes it a crucial factor in every economy. Thus, by inference financial deepening and financial widening which has become the engine of economic growth in the 21st century economies can only be achieved when stock markets perform. Stock markets capitalization globally is 86.5% of the world’s gross domestic product (GDP) as at 2010 and 98.2 % as at 2017 (World Bank, 2017).
In the sub-Sahara Africa, stock markets dates back to the early 1990s. Prior to this period there were five stock exchanges in sub-Sahara Africa compared with the current number of seventeen (17) in the region as at 2017. Stock exchanges in this region has seen growth over the past two decades although most countries in the sub region are in their formative years with regards to the financial sector.
Although the Ghanaian stock market or the entire capital market is not all that developed in terms of its capitalization, types of financial instruments currently traded in, and the market infrastructure, it however, plays a key role in the development of the economy. Ghana Stock Exchange market report for the period ended 2017 reveals a market capitalization of GH¢ 58,803.96 million representing a year to change date of 11.48% and a market turnover for fixed income securities to the tune of GH¢ 3,529.73 million. These turnovers represent capital inflows from both domestic and foreign investors into the local economy through the capital market to business. Since its establishment the Ghana Stock Exchange.
Prior to the establishment of the Ghana Stock Exchange which is the market for stocks in November 1990, two equity brokerage firms, namely National Trust Holding Company Ltd (NTHC) and National Stockbrokers Ltd, now UMB Stockbrokers Ltd, did over-the-counter (OTC) trading in shares of some foreign-owned companies. The OTC trading was established in response to the Ghanaian government’s decree of 1975 known as the “Investment Policy Decree”. This decree required foreign firms operating in Ghana to divest themselves of not less than 40% of their equity capital to indigenous Ghanaians.

The Ghana Stock Exchange has been in existence for almost twenty seven years now. Even though it is a relatively new emerging market when compared to other stock exchanges in the advanced economies it has not done badly. Ghana Stock Exchange in 2003 become one of the World’s best performing stock market with a return of about 154. 67%.
The GSE All-Share Index (now called the composite index), which is a measure of the general performance of the stock exchange, has posted some significant index levels since its inception. The index grew from 70.25 in December 1990 grew to 857.98 by the end of December, 2000. Although the index maintained an upward trend, it suffered set back in some years (2005 and 2009).
In terms of returns, the GSE posted high returns from 2000 to 2004, and also from 2006 to 2008. Nonetheless, it recorded negative returns in the following years, 2005, 2009, 2015 and 2016. The decline in the index from 2014 to 2016 which resulted in negatives has been attributed to higher interest rates. For instance, interest rates (90- day Treasury bill rates) hovered around 20 to 25 percent. 90-day Treasury bill rate for January 2014 started at 19.33 and by December, 2014 the rate was at 25.79%. The following year, 2016 was no different. Interest rates for the period still remained high. January to June interest rates was still at the following levels respectively, 25.83, 25.62, 25.55, 25.18, 25.09, and 25.17.
Stock market returns is a function of other macroeconomic variables of which interest rates is included. Economic theory reveals a negative relationship between interest rates and returns on stock. The impacts of interest rate on stock exchange provide important implications for monetary policy, risk management practices, financial securities valuation and government policy towards financial markets. Interest rates act as the cost of the capital to companies or the cost of borrowing. It is the price paid for the use of money for a period of time. From the point of view of a borrower, interest rate is the cost of borrowing money that is borrowing rate. From a lender’s point of view, interest rate is the fee charged for lending money that is the lending rate. They are also returns on the alternative assets, such as savings accounts and treasury bills or fixed income securities. As the cost of capital, interest rates influence the profitability and the value of the listed companies. If a company pays a very high interest rate on its debt capital, its earnings potential will be eroded, hence investors will mark down its value (Uddin and Alam 2007).

Interest rate has a wide and varied impact upon the economy. When it is raised, the general effect is a lessening of the amount of money in circulation, which works to keep inflation low. It also makes borrowing money more expensive. This increases expenses for companies, lowering earnings somewhat for those with debt to pay. Finally, it tends to make the stock market a slightly less attractive place to investment. The swings in the stock market results in higher interest rates which make a company’s potential future earnings to look less attractive, therefore, the value of the company and the stock price should be adjusted downwards. Interest rates are among the most important factors affecting the fluctuations in stock trends. Also increase in interest rates makes fixed incomes securities more attractive than listed equities on the stock market. Investors therefore tend to move out of the stock market into investing in treasury bills, treasury notes, and other money market instruments. Higher interest rates leads lowering private investment, thus, “crowding out”. (Keynes, 1930). Thus interest rate hikes dampen the performance of the stock market.

Understanding the effects of interest rate on stock market performance provides important implications for policies towards financial market development (Asamoah, 2016).
The research will reveal the connection between interest rate and stock market. The most important intention of this research is to study the relationship between Interest rate and stock market performance in Ghana.

Problem Statement
Stock market plays a major role in an economy. First, stock market returns or performance serves as an indicator to the future outlook of an economy including, the economic and financial health (Hamrita and Trifi, 2011). Second, stock market returns provide a source of information regarding the expectations and risk attitudes of the market. Stock market returns also facilitate an evaluation of investments and offer attractive properties for conducting statistical analyses (Lo, Campbell ; Mackinlay, 1997). In summary, stock market returns provide useful information for making various forecasts, developing regulatory rules, constructing portfolio strategies or determining implications of policies.

In economic theory, stock market returns are a function of exchange rate, inflation rate, and interest rate (Chen, Roll and Ross, 1986; Gupta and Modise, 2013). It is therefore important to have a clear understanding of the stochastic properties of stock market returns as well as the properties of the individual macroeconomic variables. However, debate on the stochastic properties of stock market returns and each of the macroeconomic variables remains unsettled. This research seeks to examine the relationship between interest rate and stock prices in order to identify the impact of interest rate changes on stock prices and in general the performance of the stock market with special reference to the Ghana Stock Exchange.
Objectives of the Study
The main objective of the study is to examine the influence of interest rates on stock market performance in Ghana. Specifically, the study seeks to:
Identify the short run impact of interest rate on stock market returns.

Determine the long run impact of interest rate on stock market returns.

Establish the causal relationship of the interest rate and stock market returns.

Examine the stochastic properties of interest rate, stock market returns and their cointegrating residuals.

Research Questions
The research seeks to find answers to the following questions:
What is the impact of changes in interest rate on the stock market returns?
Is there any short run impact of changes in the interest rate on stock market returns?
Is there any long run impact of changes in the interest rate on the stock market returns?
What are the stochastic properties of interest rate, stock market returns and that of their cointegrating residuals?
Justification of the Study
Investigating the impact of interest rate on the performance of the stock market in Ghana has many potential benefits to literature, practice and policy. The study brings to the fore evidence on how stock market performance is affected by the changes in interest rate in the Ghanaian economy. Additionally, the paper highlights the need for prudent policies on interest rates thus contributing to literature. It further discusses the implications of this policies and how it promotes the growth and development of the capital market in Ghana.
This study will also be beneficial to academia by providing much needed insight to lecturers, students, instructors and other future researchers on the subject matter as well as serving as a source of reference. Furthermore, understanding the behaviour of interest rate towards the stock market in Ghana can help the foreign as well as the local investors, fund managers, and capital market analyst to carefully plan their investment and building their portfolio management.

Scope of the Study and Delimitation
The study will use monthly data spanning from the period 1st January, 2000 to 31st December, 2017 on 91-Day Treasury Bill (representing interest rates), and Ghana Stock Exchange (GSE) returns. The study explores the effects of the interest rates on the GSE returns.
Moreover, whereas several factors influence stock market returns, this study will focus only on interest rates. The exclusion of other macroeconomic variables could probably give a better prediction on the stock market performance to the economy. Further, the GSE return index serves as a proxy to stock market performance. This index however includes the capital gains component and not the dividend that accrues to each stock thus limiting the full impact of the returns captured. These constraints may limit the application and generalization of the research findings.
In investigating the relationship that exist between the Ghana Stock Market performance and interest rate, the GSE returns and the 91-Day Treasury bill rate, will be used as a proxy for the measurement. Secondary data was collected from the year 2000 to 2018 on the above from the Bank of Ghana (BoG) Statistical Bulletins, Ghana Stock Exchange Market Report and the World Bank Indicators 2017. The BoG bulletins provided data on interest rates and inflation rates. The GSE market report provided data on the GSE All Share Index (now called the composite index) and the stock market returns.
Model Specification
The study will adopt the model used by Sangmi and Mubasher (2013) in their work on macroeconomic variables on stock market interactions. The authors used the model to examine the effect of six macroeconomic variables (inflation, exchange rate, Industrial production, Money Supply, Gold price, interest rate) on the stock price movement in Indian Stock Market over the period of April 2008 to June 2012.
The research will use time series data on 91-Day Treasury bill Rate, and stock market returns from 2000 to 2018. The model expresses stock market returns (SMR) as a function of selected macroeconomic variables. The model is specified as:
SMIt =?0+ ?1WPI + ?2ExR+ ?3IIP + ?4M3 + ?5GP + ?6IR + ?i (1)
SMI= Monthly percentage change in the stock market index
WPI= Monthly percentage change in the Wholesale price index
ExR= Monthly change in the exchange rate
IIP= Monthly percentage change in the index of production
M3= Monthly change in the money supply
GP= Monthly change in the gold price
IR= Monthly change in the interest rate
?i= Error term
?0=constant term
?=coefficient of variables
To investigate the relationship between stock market returns and interest rate the following model will be adapted;
SMRt =?0+ ?1INFt + ?2ExRt+ ?3INTt +?t(2)
where SMR is the logarithm of the stock market return; INF is the logarithm of the consumer price index; ExR is the logarithm of the exchange rate; INT is the logarithm of the interest rates, ? is the error term assumed to be normally distributed.

Given the above stochastic model, the identification strategy for the estimable model follows the steps below. First, the basic descriptive statistics will be calculated using the data collected on the variables. Secondly, a unit root test will be performed and finally a vector error correction model will be specified to estimate the long–run causality and short-run dynamics.
Organization of the study
The study is divided into five chapters that cover various sections of the study. Chapter one introduces the subject matter of the study. This is followed by an extensive review of existing literature in chapter two that cumulates in the construction of a conceptual framework that acts as a basis for the study. Chapter three, methodology, expounds the means by which the research endeavour will be executed. It outlines the model specification, variable definitions and analytical strategy of the study. Chapter four presents the research findings and details the analysis carried out. Chapter five concludes the study by proving summaries of observations made and recommendations
Empirical evidence:
Empirical evidence from advance countries
Levy (1987) asserts that the volatilities in the USD exchange rate can harmfully influence the gross profit of a firm; however, the extent of such impact varies from one sector to another. His research also revealed that the fluctuations in the USD external value have an extreme impact on profits of producers of durable goods as compared to certain service industries. In contrast, Sonnen and Hennigar (1998), in their study revealed an indirect connection between changes in exchange rate in the USD and industrial stock price indices.
According to Loudun (1993) in his research during the post-float phase (Between January
1984 and December 1989) in Australia regarding the stock performance sensitivity of certain organizations with regard to the changes in the value of trade weighted index of the Australian Dollar. It was also proven that industrial resource stocks and stock respond in a different way to fluctuations in Australian Dollar. Banny and Enlaw (2000) also unearthed the relationship between the exchange rate of the Malaysian Ringgit in the area of the US dollar and stock prices in Kuala Lumpur Stock Exchange market (KLSE) by means of applying a single and multi-index models. They ended the research with a note that the KLSE stock prices and exchange rate are negatively related.

Ying Wu (2001) in examining the impact of macroeconomic variables on the Straits Times Industrial Index (STII) categorized the macroeconomic indicators into two groups namely money supply and interest rates. His findings was that money supply does not register any pattern of influences on the STII but interest rate does play a significant role in determining the STII on the monthly investment perspective. When time series data from January, 1982 to December, 2002 on selected macroeconomic variables of major stock indices of United States and Singapore were used to examine the long–run equilibrium relationship between the two countries, Wing et al. (2005) discovered through a cointegration test that Singapore’s stock prices generally display a long-run equilibrium relationship with interest rate and money supply but similar relationship does not exist in the United States market
Elton and Gruber (1988) also discovered that there exists a positive relationship between stock prices and short-term interest rates. Chen et al. (1989) examine the effect of discount rate changes on the volatility of stock prices and on trading volume. The authors discovered that unexpected discount rate changes contributed to higher, though short-lived, volatility and trading volume. Smirlock and Yawitz (1985) discovered that an increase in interest rates causes stock prices to decline and a decline in interest rates causes stock prices to rise. Further, they conclude that if both capitalization rates and expectations about future cash flows are impacted by interest rates, these effects would influence equity prices.

Hasan and Samarakoon (2000) examined the ability of interest rates, as measured by Treasury bill yields, to track expected monthly, quarterly and annual returns in the Sri Lankan stock market during the 1990-97 period. The stock return is measured by the continuously compounded monthly returns on the All Share Price Index (ASPI) and Sensitive price index. Through the application of the OLS method it was suggested that the short-term interest rates are positively related to future returns and they are able to reliably track expected returns prospects. The authors also concluded that the 12 months maturity is the most powerful tool to track monthly and quarterly expected return among all the three maturities. Goswami and Jung (1997 investigated the effects of economic factors on Korean stock market.,the employed the Vector Error Correction Model (VECM), to verify the short-run dynamics as well as long-run relationship between stock price and nine macroeconomic variables from Korean economy. The economy revealed that Korean stock market,is cointergrated with,nine macroeconomic,variables also Korean stock prices are positively related to industrial production, inflation and short-term interest rate, and negatively related to long-term interest rates and oil prices. The authors also concluded that foreign exchange rate changes may affect stock prices in either direction whiles Devaluation of Korean Won,against US Dollar (Japanese Yen) is positively (negatively) related to stock price changes.

Again on the nexus between macroeconomic variables and stock exchanges, Mukherjee and Naka (1995) found that the relationship between the Tokyo Stock Exchange (TSE) and the exchange rate was negative (that is, the TSE increases as the Japanese yen depreciates against the US dollar). This result is consistent with the goods market theory. However, the economic effect of stock markets on emerging markets is less clear. Also in the study to provide an empirical evidence of stock market sensitivity to interest rates and inflation in UK, Nicholas (2003) examined the behavior of nominal and real interest rates and monthly total return of 35 industry indices and 10 sector indices as well as four financial times indices. His results after running a simple linear regressions revealed that interest rate movements are important determinants of equity return variability and all the industries other than forestry and paper, sectors and market portfolios are negatively related to interest rate changes. Also utilities have the highest sensitivity to movements in nominal interest rates because of their high exposure to inflation. Per the statistical outputs, he concluded that there are significant differences between interest rate and inflation sensitivities across all economic sectors
Evidence from Developing Countries:
Kumar (2009) observe show the relationship between the ‘All share index’ and exchange keeps on changing. A daily dataset from India was used to carry out the research. He also adopted the unit root and co-integration tests to test for the long run relationship between the two variables. Again, in order to examine the dynamic relationship between the two variables, the study adopted the linear and nonlinear granger causality tests to remove the volatility dependence from the series. In conclusion, the study revealed that there are no long-run relation between the All share index and exchange rate. However, there is bidirectional linear and nonlinear granger causality between stock index and exchange rates. Muhammad and Rasheed (2002) employed co-integration, vector error correction model technique and standard Granger causality tests to examine the long-run and short-run association between stock prices and exchange for four countries namely India, Pakistan, Bangladesh and Sri- Lanka for the period January 1994 to December 2000 on monthly data collected. The study discovered that no short-run alliance exists between the variables and the above stated countries. Again, in the case of Pakistan and India, there is no long-run relationship between stock prices and exchange rates as well. However, for Bangladesh and Sri Lanka there appear to be a bi-directional causality between these two financial variables.

Bhattacharya and Mukherjee (2003) also conducted an empirical study to find out whether there exist an empirical relationship between the prices of stock and certain macroeconomic variables which took place in India. Econometrics techniques such as unit root tests, co-integration and the long-run Granger non-causality test recently proposed by Toda and Yamamoto (1995), to test the causal relationships between the Bombay Stock Exchange Sensitive Index and the three macroeconomic variables; exchange rate, foreign exchange reserves and value of trade balance using monthly data for the period 1990-91 to 2000-01. They conclude that there is not any causal relation linking stock returns and the variables.

Abdalla and Murinde (1997), examined the relation between stock prices and exchange rates for four Asian countries namely; India, Pakistan, Korea and the Philippines using monthly data covering the period 1985 and 1994. The study adopted an econometric method of integration, to find that there are no long-run relations between the two financial assets for Pakistan and Korea but in the case of Korea and India, the study found that there is a long-run relationship among the variables. The research findings also revealed that, there was a unit-directional causality from exchange rate to stock prices in Pakistan and Korea. Since there was the existence of long-run relations for India and the Philippines, the study used an error correction model to examine the causality for the two countries. The causal relation for India was from exchange rate to stock prices but the reverse was true for the Philippines; in each case the relation was unidirectional.

On the other hand, Bahmani and Payesteh (1993) proved that, in the short run there exists bidirectional causality between stock prices and exchange rate, although the cointegration analysis does not depict any long-term relationship between these variables. However, in a study conducted by Qiao (1997), he reports that there is a bi-directional relationship that was in existence in the stock prices and exchange rate of the Tokyo stock market. Findings from other research expressly indicate that the interest rate and exchange rate changes have an effect on the stock market in the long run, however such evidence is not the case in the short run since the influence is insignificant. According to Amaresh das (2005) on his study on the interrelations between the stock prices which is indicated by market ratio and interest rates which is also measured by three month Treasury bills for monthly observation from 1985 to 2003 for three Asian countries involving Bangladesh, Pakistan and India, the codependence among variables shows that the relationship between stock prices and interest rate is not significant for Bangladesh and Pakistan. The paper in addition documents that the time series data for Bangladesh and Pakistan reflects robustly common cycles.

Evidence from Africa
Ocran (2010) conducted a research on the pragmatic correlation that exists between the stock prices of South Africa and the US and the rand and the USD exchange rate. The study adopted the Johansen cointegration technique, the Granger causality test, generalized impulse response function and forecasting error variance decompositions for the analysis. In the estimations of the results, the study used a monthly dataset of all the variables covering from January 1986 to November 2005. However, the Johansen cointegration test could not identify any long-run relationship between the variables of interest.

Adjasi and Biekpe (2005) examined the relationship between stock market returns and exchange rate movements in seven African countries. The cointegration tests conducted it revealed that exchange rate depreciation causes an increase in stock market prices in the long-run of some of the countries whereas in the short-run exchange rate depreciations cause a reduction in the stock market returns. Subair, K. and Salihu, O.M. (2010) looked at the annual stock market capitalization, GDP, inflation rate, interest rate and exchange rate fluctuations from the period between 1981 to 2007. Using error correction model (ECM), the research ascertained the effects of exchange rate volatility on the Nigeria stock markets. Their study revealed that exchange rate volatility mostly exerts a stronger negative impact on the Nigeria Stock markets.

Evidence from Ghana
Adjasi et al (2008) analysed the effect of exchange rate volatility on stock market in Ghana in addition to the effect of other macroeconomic variables on stock market volatility. The authors tried to find the nature of volatility in both the stock market and the exchange rate from 1995 to 2005. The findings indicated that there is an indirect linkage between exchange rate volatility and stock market returns. The study also revealed the presence of volatility shocks of the exchange rate on stock returns on the Ghana Stock Exchange, and thus indicating that variations in the tradeoff between risk and return is knowable and in the process serving as a valuable tool for risk management.

Adam and Twenenboah (2008) investigated the role of macroeconomic variables on stock
price movement in Ghana by means of Databank Stock Index, Treasury Bill Rate, Consumer Price Index and Exchange Rate as macroeconomic variables. He used the Johansen’s multivariate cointegration test and Innovation accounting techniques for the analysis and the conclusion was that there is cointegration between macroeconomic variables acknowledged and stock prices in Ghana signifying a long run relationship.

Additionally, Kuwornu and Owusu-Nantwi (2011) upon investigation established that Treasury Bills rate and exchange rate had significant negative effect on stock market returns in Ghana. The authors used monthly data of the 91-day Treasury Bills rate, exchange rate, consumer price index (CPI) and stock market returns from 1992- 2008. The authors adopted the full information maximum likelihood estimation procedure.
Kuwornu (2012) further investigated how the Ghanaian stock market can be impacted by changes in some macroeconomic variables. He used monthly data from 1992 to 2008 and also employed the Johansen cointegration technique in analyzing the data. The macroeconomic variables involved in the study were consumer price index, exchange rate, 91 day Treasury bill rate and crude oil price. The results of the study revealed that there exist a significant long run equilibrium relationship between the four macroeconomic variables and stock returns in Ghana
On the other hand, Ado and Sunzuoye (2013) failed to establish any significant negative relationship between the Treasury Bills rate, lending rate and stock market returns in Ghana
Asamoah et al (2016), investigated the impact of interest rate on stock market capitalisation in Ghana using monthly data for the period July 2011 to April 2015. The autoregressive distributed lag bounds test approach to cointegration was used for the estimation. Their study revealed that, in the long run, interest rate improves stock market capitalisation whilst the opposite is true for the short run.
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