Monetary Policy and the Stock Market: Empirical Evidence from Nigeria - Research Proposal Example

The major findings include the impact of long run monetary policy on the stock market returns of Nigeria. The stock market returns get reduced because of high rate of Treasury Bill. This provides the evidence that efforts in monetary policy contributes in slowing down the economy. The returns in stock market witness a positive effect from current interest rate and interest rate lagged by one period. The sign of lagged error correction is negative. The feature of the variance decomposition results is that the sources of fluctuations of returns are largely due to shocks in stock market as well as interest rate.

Thus, innovations of interest rate can act as the estimator in the returns in stock market in Nigeria. Preliminary introduction The monetary policy of a country controls the money supply by the process of monetary policy. The authorities target a rate of interest with the aim of providing stability and growth in the economy. The objectives of the authorities include relatively stable prices and lower rate of unemployment. When a monetary policy increases the supply of money in the economy, it is said to be expansionary and when the same policy leads to contraction of money supply, accordingly, it is said to be contractionary. . The impact of movement of exchange rate on the competitiveness of the firm and the position of the balance of trade is explained by flow models.

If there is reduction in stock prices, the wealth of the investors will get reduced affecting the liquidity in the economy (Okpara, 2010, p. 2). The second model explains the link between the stock market and the exchange rate through the capital accounts of a country. The returns on foreign currency will increase if the currency of Nigeria, Naira, depreciates against other foreign currency. This will induce the investors to divert funds from domestic assets towards the assets of the foreign currency which will reduce the prices of the stocks.

The monetary policy has been transmitted through liquidity channel, credit channel and the channel of exchange rate in Nigeria. The interbank market rates acted as the source of transmission in the country when the structural adjustment program came into effect. Although several studies have discussed the correlation between stock market and other macroeconomic variables, but none has taken the monetary policy variables into account (Adebiyi, 2005). A co-integration and error correction model can be used for this purpose.

To study the long run equilibrium relationship, the gross domestic product can be used as the dependant variable and number of securities, turnover ratios and capitalization of market can be used as the independent variable. The study showed that an increase of one percent in stock market capitalization ratio can lead to thirty percent increase in real GDP which, in turn, demonstrates the existence of long run equilibrium relationship among the variables. The motivation under the study is to enable the decision makers to understand the