Dynamic relationships between stock market performance and short term interest rate Empirical evidence from Sri Lanka

This study examines the dynamic relationships between stock market performance and the interest rates in Sri Lanka during June 2004 to April 2011. We use all share price index in the Colombo stock exchange as a measure of stock market performance indicator and Sri Lanka interbank offer rate as a measure of interest rate. We employ some conventional time series econometric techniques namely Unit root test, cointegration test, vector auto correction model (VECM), Granger-Causality test and Impulse response functions (IRF) to trace out the relationships between stock market index and interest rate. The findings of interest include stock market performance is negatively associated with interest rate in the long run while no causal relationship is found in the short run. Keywords— Time Series, Colombo Stock Exchange, Interest Rate, VECM, Cointegration Asankha Pallegedara is with the department of Industrial Management at the Wayamba University of Sri Lanka, Kuliyapitiya (corresponding author to provide phone: 077-1898881; e-mail: [email protected]).