Relationship between Interest Rates and Stock Price: Evidence from Sri Lanka

The macroeconomic variables have a strong influence on stock market activities. Colombo Stock Exchange (CSE) Sri Lanka shows a rapid growth in recent years and All Share Price Index (ASPI) is the evidence for that. This study attempts to identify the relationship between interest rates, which are Repo rate, one - year maturity Treasury bill rate and Saving Bank's one - year maturity fixed deposit rates and ASPI of CSE with a monthly observation from January 2005 to October 2011. The Augmented Dickey - Fuller Unit Root test proves that there is no serial correlation among variables. The variables are I(0) and cointegration test proved that the variables have long - run relationship. The problem of heteroskedasticity is detected and the heteroskedasticity corrected (white method)Generalized Liner Regression (GLS) results suggest that interest rate variation 44% on ASPI and the F value is significant at 1% level. Granger Causality test identifies the Repo rate and Treasury bill has causality problem. Therefore, the study concludes that the interest rates have strong impact on stock price.