The Effects of Interest Rates Volatility on Stock Returns: Evidence from Bangladesh

The paper investigates the effects of interest rates on stock market performance by using monthly time series data for the economy of Bangladesh over the period of 1991 to 2012. A wide range of econometric techniques have been employed to analyze the relationship between the interest rate and stock market return. The study reveals a stable and significant long run relationship between the variables. By employing Cointegration technique it is observed that in the long run, a one percent increase in interest rate causes 13.20 % decrease in market index. The estimated error correction coefficient indicates that 0.12 percent deviation of stock returns are corrected in the short run. Impulse response function of the study also affirms the negative relationship between the variables. The result of Variance decompositions suggests that about 99.57 % of the variation in stock market returns is attributable to its own shock which implies that stock market returns are largely independent of the other variables in the system. Finally, Granger causality analysis suggests the existence of a unidirectional causality from interest rate to market index.