Unexpected Interest Rate Adjustments’ Impact On The Stock Market

As an important part of the monetary policy transmission process, the reaction of the financial markets on the monetary policy stance of the central bank and its open market operations has been one of the most concerned topics for policy makers, market participants and academic researchers. What are the exact impact and its mechanism of Monetary policies on the financial markets, and how can the central bank measure the effect its monetary policy, these are questions still need urgent answers. According to the efficient market theory, the existing market price has already fully reflected the status of all the existed factors, so only new informations which are not expected by the market are able to influence the market. Therefore, on the impact of interest rate adjustments on the stock market, foreign scholars have introduced expected factors, and started to study the impact of central bank interest rate surprise for market through the use of interest rate futures and questionnaires to decompose central bank’s interest rate adjustments. However, because of the slow development of China’s financial markets and other reasons, Chinese scholars’s study on this issue has not involved with the decomposition of interest rate adjustments.This paper attempts to separated the expected component of central bank interest rate adjustments by two methods:one is to through the use of the interbank offering interest rates to build a virtual one-month forward futures interest rate, then based on the interest rate adjustments before and after long-term futures to measure the unexpected interest rate changes; another method is to use the one month interbank offering interest rates changes as the market participants’ expectation on central bank interest rates adjustment. We found that the use of virtual one month interest rate futures is obviously better than the two-month interbank offering interest rate in the decomposition effect.The empirical results show that while the central bank’s interest rate adjustments have no significant impact on stock market’s return and volatility, the unexpected part of it has a significant negative effect on China’s stock market gains rate. This means that unexpected increases(decreases) result in a decrease (increase) in stock market returns. This conclusion is consistent with the traditional financial theory and foreign scholars’previous study. We also found that the stock market has a significantly different response to interest rate adjustments in different time spans, and the unexpected interest rate adjustments on the stock market is mainly concentrated in the period after2007while no significant corresponding relations between stock market and interest rate adjustment was found before2007. This conclusion proves that after the year of2007, China’s stock market has became more mature and its importance in the monetary policy transmission function has been improved. In addition, we also investigated asymmetric effects between the positive interest rate adjustments (bad news) and negative interest rate adjustments (good news) on the return of stock market. We found that the only the positive unexpected interest rate adjustments affected stock market yields and volatility. Positive unexpected interest rate adjustments (bad information) leads a fall in yields in the adjustment day and the first following trading day, and cause substantial increase in market volatility in the second trading day, both impact is statistically significant; In contrast, negative unexpected interest rate adjustments (good news) have no significant effect on neither stock market return or volatility.Finally, according to the conclusions of the our empirical results, this article attempts to give following policy recommendations:speed up the development of China’s stock market, take greater emphasis on market expectations during the process of decision-making, and push forward the reform of the interest rate’s marketization firmly, so as to improve the financial market’s sensitivity to the central bank’s adjustment of benchmark interest rate and rationalize the monetary policy transmission channels through the gradual relaxation of interest rate controls.