The Relationship between Interest Rate and Stock Market Index in Zambia –A Cointegration Analysis

The Lusaka securities exchange is one of the developing stock market in Southern Africa. It is therefore imperative to study the factors that can contribute to its development. One of such factors is the interest rates. According to Ali (2014) the higher the interest rate, the lower the efficiency of the stock market, this is because if investors are getting higher returns from investments like bonds and treasury bills they will invest less in stocks. This implies that interest rates should have a negative relationship with the stock market performance. However, this relationship is not obvious because some studies have found a weak or no relationship between the interest rates and the stock price (Muthukumaran and Somasundaram, 2014; Khan et al, 2012; Chirchir, 2013). This study, therefore, sought to investigate the relationship between Interest rates and stock price index in Zambia. Cointegration analysis was used to estimate the long rung relationship and the Error Correction model was used to estimate the short term relationship on stock price index, and interest rates for the period 2004-2016. The results indicate the existence of cointegration (long run) and short run relationships between the stock price index, and Interest rate. The policy implication of this study is that if the interest rate is considerably controlled by reducing it, it will be of great benefit to the borrowers (companies and individuals) as they will access cheaper capital. Most importantly, it will be of great benefit to the development of the stock market in Zambia as this will act as a demand pull way of more investors from investing in debt to investing in stocks. In the long run this will result in economic growth. Among the ways that the Central bank can use to reduce the landing rates is by reducing the Minimum Rediscount Rate (MRR). Reducing the Minimum Rediscount Rate (MRR) will have a spillover effect on the reduction of lending rate as this is the rate at which the central lends to commercial banks hence, it sets the floor for the interest rate regime in the money market. Furthermore the central bank should consider reducing the Reserve Requirement of the deposit that commercial banks deposit with the central bank so as to increase the money supply which may contribute to the reduction of interest rates in the long run.