Dynamic Linkage between Monetary Policy and Stock Performance in Nigeria: Cointegration and ECM Techniques

Abstract

Aims: To explore the dynamic relationship between stock performance and the monetary policy instruments that influence Nigeria’s stock market activities. Study Design: It uses secondary data collected from the Central Bank of Nigeria (CBN) Statistical Bulletin. The annual time series data cover a period of 38 years, from 1981-2018. Methodology: The Augmented Dickey-Fuller (ADF) unit roots' test technique was used to verify the variables' time-series properties while the Johansen procedure was applied to confirm cointegration among variables. The short- and long-run relationships were analyzed after estimating the vector error correction model. Common diagnostic tests were conducted to validate the robustness of the model estimates. Results: The results of tests of unit roots reveal all included variables as integrated of order one, I(1). The Trace-statistics showed that at least one cointegrating relationship exited among the time series, and the ECM was estimated. The emerging error correction term equation revealed the stock market performance as inversely related to both the credit to the private sector and the lending rate, but positively related to the money supply. Each variable was statistically significant (P<0.01). Also, the error correction term was well-behaved, being statistically significant (t=-3.17; P<0.01) and the desired negative sign, implying that previous periods' errors are correctable by adjustments in the subsequent periods, and to attain convergence. The error term had an adjustment speed of 44.19%. Granger-Causality analysis revealed a unidirectional causality relationship between the stock performance and the lending rate, with causality running from lending rate to stock performance, without a boomerang. The implication of the findings are threefold: the subsisting restrictive interest rate policy is unfavorable to long-term investment from the investors' perspective; the existing terms and conditions of the commercial credit packages had proven to be disadvantageous to long-term investment in Nigeria; and money supply as a monetary policy instrument in Nigeria had been used to boost investment and stock market performance. It is recommended that boosting investment and performance of the stock market in Nigeria would require the use of a more investment-friendly commercial lending rate, and relaxation of the stringent terms and conditions attached to the commercial private sector credit and loan packages. These measures would guarantee better access to fund and enhance ease-of-doing-business for investors.