The relationship between interest rates and stock returns: Case study on BRIC countries and Turkey's stock indices

One of the most important instruments of the capital markets are stocks which the funds supply and demand. A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. While stock market is among the most important investment options for investors, it also plays an important role in national economies by attracting foreign investments. In the meantime,with the development of the capital markets, share prices have became extremely sensitive to macroeconomic factors. In this study, major macroeconomic variables also were investigated for each country. Briefly, economic output or income is measured in terms of the gross domestic product, which is basically the combined earnings from a year's worth of goods and services produced by a country. A higher rate tends to indicate a more economically solvent nation. This might be accepted major macroeconomic indicator for all countries. Inflation rate a tool used to measure changes in the average price level based on a price index. This index measures average retail prices that consumers pay. A high or increasing consumer pricing index indicates the existence of inflation. Higher prices tend to reduce overall consumer spending, which in turn leads to a decrease in GDP. While inflation itself is not negative, rapidly increasing rates of inflation signal the possibility of poor macroeconomic health. One of most important macroeconomic indicators is the unemployment rate which is the percentage of the working population that is not currently employed. The percentage only takes into account the number of people who are actively seeking employment. Those who are unemployed and not seeking jobs are "voluntarily" unemployed. Many governments set benchmark unemployment rates since they are aware that a zero rate is next to impossible. If the actual aggregate unemployment rate is at or below the benchmark rate, the economy is considered to be fully employed. Final one is the interest rate which was selected as key variable in this thesis. In terms of macroeconomic reporting, the interest rate is the nominal rate. Nominal rates are not adjusted for inflation. Lower interest rates typically occur when there is a need to stimulate consumer spending. If the housing market has an excess of inventory and a decline in the number of buyers, lenders might reduce mortgage interest rates to stimulate demand. Its decided to use central bank's interest rates as a macroeconomic variable. Therefore, politicians, investors and academics have shown great interest in this dynamic relationship. The investors who aim to archieve highest return on their investments have to take macroeconomic factors into considerations. Since changes in macroeconomic factors will have a positive or negative impact on share prices, many studies have been conducted to examine which factors will have an impact on stock prices and how they will affect the way. However, when the correlations between stock prices and macroeconomic factors were examined, different results were obtained. It has also been observed that the great number of studies examining the share returns and macroeconomic variables are done by using time series analysis, panel data analysis, granger cause and multiple regression models. Goldman Sachs, one of the world's most established investment banks in 2001, represents the BRIC's definition of the four most developing countries in the world economy, Brazil, Russia, India and China are the countries in this definition. With the rapid development of international trade in these developing countries, liberalization efforts and the development of financial markets in these markets made international portfolio managers to focused on these markets and diversify their portfolios. Thanks globalization, companies have started to finance through international markets and have exported their stocks to international markets and escaped from the low transaction volumes in the national markets. At the same time, many international investors are compared Turkey with with these four developing countries in many ways. Turkey is a growing economy and offers attractive return opportunities to the investors so investors who seek highest return from their investments always think Turkey as one of alternative country which promises significant stock returns. In this thesis, the impact and relationship between interest rate decisions made by central banks and stock returns are evaluated for BRIC countries and Turkey. Central banks are one of the most important players in the economy and highly effective to impact the market both long term and short term. A number of tests have been carried out since the result obtained is time dependent. In order to evaluate this relation in a holistic way, it is used overnight borrowing and lending interest rates which decided by central banks in monthly periods. Most countries were assessed for a period of 1990-2017. All currencies are fixed to american dollar to get over other factors which might affects share price. The stocks selected in the study are the largest and mature indices in terms of average transaction volume and market capitalization in the capital market where the countries are located. As mentioned in the literature, one of the assumptions underlying in time series applications is that the date are stationary. Therefore augmented dickey fuller stationarity test, which is the most valid method for removing time series analysis from stationarity, has been performed in this thesis. Afterwards, cointegration tests were performed in order to understand the relationship period between two variables, whether is long term or short term. Cointegration is an approach developed to evaluate the link between the nonstationary time series. Exceptionally, there is a risk of the misestimating of the nonexistent association between the variables which does not mean that there is no association between the variables. Contrawise, long-term common movement can be discovered between the non-stationary time series. As a consequence, a common equilibrium of the variables can be mentioned. For cointegrated results, vector error correction model is applied. For the results which are not cointegrated, vector auto regressive model is used. After outcomes are obtained Granger causality analysis tests were conducted to evaluate whether one time series is useful in forecastion another. As a result of the Granger test, it has been observed that the change in interest rates gives different outcomes for each country and each sectoral index. The finding for each country are explained in detail in the conclusion section. As a result of this thesis, emprical studies shows that interest rate decisions taken by central banks does not have long term effects on the sector indices in China, Russia and Turkey. Moreover the findings of causality analysis reveal that the current economy can not be controlled, triggered and restrained by conventional monetary policies. On the other hand, according to cointegration and granger analysis, monetary policy decisions taken by the central bank of Brazil and India changes the stock market pricing for specified sector indices. It is determined that the control power on the main indices of capital markets will be higher than the central banks mentinoned above. It is possible to assume that similar study will lead to more detailed and different results with a few alternative macroeconomic data sets. To this end, impact-response and variance decomposition analysis might be conducted in the further researches.