Analysis of the Effect of Monetary Policy Development on Equity Prices in Nigeria.

Abstract

This study investigated the effect of monetary policy development on equity prices in the Nigerian Stock Exchange Market using annual data from 1985 to 2010. The ordinary least square regression (OLS) was run using five monetary policy variables including minimum rediscount rate, treasury bill rate, interest rate, exchange rate and consumer price index (proxy for inflation) on the equity prices (proxied by all share price index). The first investigation of this study is that minimum rediscount rates and Treasury bill rates are highly correlated and cannot be applied simultaneously in monetary policy management. As a consequence, the Treasury bill rates were dropped in the course of further analysis. The general result of the analysis showed a weak correlation between monetary policy and equity prices. This reflected in the explanatory variables which accounted only 15.6% in the changes of equity prices in Nigeria. All the explanatory variables are negatively and insignificantly related to equity prices, except the consumer price index that has insignificant positive relationship with equity prices. The study has revealed that monetary policy has not made significant influence over the prices of ordinary equities in Nigeria. What this means is that the equities market has not significantly absorbed the monetary policy impulses and therefore cannot be taken as being a good transmission channel for monetary policy implementation in Nigeria until the distortion in the financial system caused by huge fiscal spending is corrected. This study therefore recommends that policy makers should be aware of these weak monetary policy impacts on equities market, and make their decisions in a more effective manner that can link monetary policy to the equities market to ensure price stability and encourage investors.

Key words: Monetary Policy, Equity prices, transmission channels, Multi-collinearity test