The Relationship Between Interest Rate and Stock Market Index: Empirical Evidence from Arabian Countries

Abstract

This paper examines both short and long-run relationship between interest rate and Arab Monetary Fund indices for five Arabian stock market index, namely: Jordan, Egypt, Oman, Qatar and Kuwait, using monthly data selected from Arabian Monetary Fund database, for the period started from 1^st January 2014 to 30^th June 2016, and employing various econometrics tests, such as: Augmented Dicky Fuller test, Vector Auto Regression, Johansen test of Coinetgration, Granger causality test, and Variance Decomposition. The results indicate that there is a significant negative relationship between interest rate and stock market index in Egypt, while it was insignificant in Qatar and Kuwait. However, a significant positive relationship was found in Jordan and Oman.The result of Co-integration test concluded that the interest rate and the stock market index shows a long-run association only in Qatar, but not in Jordan, Egypt, Oman and Kuwait.Our Granger causality test could not establish causality of any direction between interest rate and stock market index in Oman, Qatar, and Kuwait. However there was a bidirectional relationship in Jordan, and a unidirectional relationship in Egypt running from stock market index to interest rate.Finally, the results of variance decomposition have shown that lending rate plays important role in explaining (26.54%, 26.01%) variation in Jordanian and Kuwaiti stock market prices index respectively. While only a little variation in stock index can be explained by interest rate especially in Egypt, Oman and Qatar, where it shows that shocks of interest rate explains (13.18%, 13.13%, and 0.07%) respectively.The findings of this study can be helpful for the investors for selecting optimum portfolio.Based on our findings, the study recommends further research to in depth investigating the reason behind the lack of causal relation in some countries, and employ other macroeconomic variables that could explain stock price.

Keywords: Arab Monetary Fund Indices; interest rate, Coinetgration, Granger causality test, Variance Decomposition (VDCs).