An empirical study of stock price sensitivity to interest rate

Changes in interest rates affect stock prices negatively. However, stocks are not responding equally. Some stocks are more sensitive to changes in the interest rate than others. Most of the previous studies focused only on testing the interest rate sensitivity of public utility and financial institution stocks, as interest-sensitive stocks. This research contributes-three empirical testing. First, examining the causality between the interest rates and the stock prices, in the Granger sense. Using the S&P500 as a proxy of stock market prices and Long-term government yield as a proxy of interest rate, the study concludes that there is a unilateral causal relationship. While interest rates movements Granger-cause movements in stock prices, no reverse causation was observed. Second, examining whether the interest rate sensitivities of aggregate stock prices are asymmetrical during the upward and downward interest rate cycles. Again using the S&P500 as a proxy of the stock market price and Long-term government yield as a proxy of interest rate, from 1919 to 1998. The study reveals an asymmetry of interest rate impact on the stock market prices. There is a bias to reduce the effect when interest rates are going upward than when interest rates are sloping downward. Third, investigate the contribution of some of the firm\u27s characteristics, on the interest rate sensitivity of the stock prices, such as: dividend distribution, dividend yield, payout ratio, earnings growth rate, market capital size, Beta, leverage, the firm\u27s product durability, and price/earning multiple. The study\u27s results indicate that the sensitivity is positively related to market capital, market risk (beta), product durability dummy variable, and price/earning ratio (P/E). The coefficients of market capital, beta, price/earning, are statistically significant, while the product durability dummy variable is not statistically significant. However, sensitivity is negatively related to earnings growth and debt/equity ratio, and payout ratio of which only payout ratio is statistically significant