The Study On How Interest Rate Affects Stock Market Volatility

Stock market volatility is not only one of the modern financial important issues, but also an important measure of financial market risk. As a measure of capital market yields fluctuations, Stock Market Volatility is also the base of asset pricing, portfolio selection and risk management reflecting the financial market stability. Interest rate is the benchmark for money market, standard of financial assets pricing and indicator of concern when investors are making decisions. Changes in interest rates, not only reflect the intention of the central bank monetary policy to a large extent, but also affect the stock price and the benchmark for asset allocation, therefore, understanding how interest rate affects stock market volatility, especially the transmission mechanism, will be of great theoretical and practical significance.Many Chinese scholars have made a lot of work about how interest rates affect stock market volatility, so I will show an overall view. Firstly, most of the studies adopted the adjustment of benchmark interest rate by central bank as the measure of interest rate changes. And they made use of dummy variables in the model when doing empirical analysis. Because of the limited data of interest rates adjustment, which result in smaller sample size of data, it is difficult to estimate the model effectively, not fully reflecting the changes in interest rates and the currency market conditions. Secondly, the research on the volatility of stock market, different scholars introduced the interest rate changes into the GARCH models differently. There is no distinction between good yields Equation (also known as the mean equations) and the condition variance equation when they did the theoretical analysis. Finally, only the Dai Xiaolan simply distinguished the interest rate changes, otherwise other scholars. They did not make the corresponding decomposition of the interest rate, only study the general affection on stock market volatility.To solve the above problems from two angles of innovation:the model of how interest rate affects stock market volatility and the specific perspective of how interest rate affects stock market volatility.1. The model of how interest rate affects stock market volatility. When investors make investment decisions in money market and capital market, they compare the market rate of return and change their own asset allocation and investment decisions. The standard for comparison in money market and capital market is the relative rate of stock returns relative interest rate, from the perspective of the stock market. Supposing the stock market rate of return constant, when interest rate goes up, the relative rate will decline, meaning the stock market become less attractive to investors, and the investors will allocate more to funds market or leave the stock market; when interest rate declines, the investors will put more funds into the stock market, or re-enter the stock market. By changing the relative rate of return in the stock market, changes of interest rates will cause investors to change their asset allocation, and affecting the stock market rate of return. On the basis of the above analysis, we know that interest rates will affect the stock prices by the discounted factor in the equation of asset pricing and the relative rates of return. The interest rate's change in the money market will cause investors to change the investment decision in the money market and stock market, such as the capital allocation, which will inevitably form exogenous shocks on the stock market, to a certain extent, changing the stock market volatility. Interest rate as investors the opportunity cost of investing in the stock market, which may affect investors'participation in the stock market, thus the amount of market information can be considered a function of the interest rate, and the interest rate can be an alternative variable as market information, the paper focuses on the establishment of the model that how interest rate affects stock market volatility from this point.2. The specific perspective of how interest rate affects stock market volatility. Different period's interest rates represent the corresponding opportunity cost of stock market. Interest rate changes affect stock market investors to choose investment products with different period. Short-term interest rates rise, will cause speculators to abandon some short-term operation; and medium-term changes in interest rates will affect the investment behavior of investors in the medium term; so the long-term interest rates change. It can be found in different period of interest rate changes, investors adjust the asset allocation in the reaction time is not the same, in general, changes in short-term interest rates will soon be reflected in the behavior of investors, and long-term interest rates change is a process, been reflected in investor behavior. Accordingly, the different duration of changes in interest rates affect the volatility of the stock market in different degrees. As to changes in interest rates, investors usually predict the future on the basis of its past performance. Except the expected part already affecting investment behavior, only that haven't expected can do effects on investors'decision. The impact of interest rate on stock market volatility is different, because of the transmission mechanism of the expected and unexpected parts. In order to study the different effects, we need to decompose interest rates. We can use linear time series model such as ARMA model for decomposition of interest rates. Dividing interest rates into the rising part and the falling part, we can introduce the two into the equation of conditional heteroscedasticity, to establish stock market volatility model for interest rates rise and fall.Thesis use empirical research methods, combining the corresponding theoretical analysis. The main use in the empirical are the GARCH and ARMA models, time series of the ARMA method, can be well on the financial data such as earnings and interest rates for the linear fitting, and forecasting; and GARCH models for financial asset return volatility have good empirical results, particularly on the stock market volatility has been widely used. In order to better reflect how interest rates affect stock market volatility, increase the accuracy of the model, select the Shibor and the Shanghai Stock Index from October 10,2006 to February 26,2010. Main conclusions are as follows:First, the relationship between interest rates and conditional volatility is positive, in details it is that rising interest rates will increase stock market volatility, the affection of interest rate decline on stock market volatility is not obvious. There is leverage effect in the affection of interest rate on the stock market volatility, because change in interest rate is a kind of stock market news. Interest rates'rising, not only makes the opportunity cost of investors to participate in the stock market increase, and indicates that tighter macro-control policies, reduction of the allocation of assets in the stock market, reducing risk, making the amount of information involved in the stock price decrease, resulting in fluctuations tolerance. On the interpretation of the intensity on the stock market volatility, because interest rates can affect the amount of information, but not the content of information, much lower interest rates to influence stock market volatility.Second, the paper uses ARMA (1,1)-EGARCH (1,1) for four different term interest rate, interest rate affects on the stock market volatility weakened with the increase of time. For the interest rate with the same period, between lagged terms and the current periods did not show a certain degree of regularity. In the empirical process, for the determination of interest rates lagged terms, the impact over the period of interest rates may still be significant due to strong correlation. So the thesis has not got consistent results.Finally, expected and unexpected parts of the interest rate affect the stock market volatility on the different mechanisms because investors made decision at different times. The unexpected part beyond the knowledge and analysis capabilities of investors, as a random shock of the current period, reflected in the investor's current decision-making, and thus in current impact of stock market volatility and lagged terms were not significant. From the expected part's the mechanism of action, investors expect interest rates' change in the future, gradually change asset allocation in the stock market's, in the process of asset allocation adjustment the interest rate gradually had an impact on stock market volatility. The transmission process is limited by time of interest rate.