Dynamic Relationship between Interest Rate and Stock Price: Empirical Evidence from Colombo Stock Exchange

This study examines the causal relationship between stock price and interest rate, using monthly data for the period from January 2007 to December 2013. All Share Price Index (ASPI) in Colombo Stock Exchange is used for the stock prices and the details on interest rate have been collected from the data released by the Central Bank of Sri Lanka. Augmented Dickey Fuller test was used to find out the stationary of the data series and the results of the test showed that, ASPI data and the interest rate was stationary at first difference. The Granger Causality test was used to check any causal relationship between stock returns and interest rate and outcomes showed that, there is one way causal relationship between variables. That is stock returns does not Granger Cause interest rate but interest rate does Granger Cause stock returns. Finally, to check the result of the Granger Causality Test, a regression was run. The result of the regression shows that interest rate is a significant factor for stock return changes and interest rate has significant negative relationship with ASPI.