REACTIONS OF STOCK MARKET RETURNS ADJUSTMENT TO MONETARY POLICY IN NIGERIA: ECM APPROACH

Abstract

This paper seeks to examine the reaction of stock market returns to monetary policy shocks of selected monetary policy instruments in Nigeria for the period 1985-2016. The long-run impact of the monetary policy instruments was also critically analyzed to determine the speed of adjustment of the market. This period was considered due to the liberalization of the financial sector. Stock market returns proxied by end-period total market capitalization was regressed against selected major monetary policy instruments; deposit money bank 12-month deposit interest rate (BDR), broad money supply (BMS) and inflation rate (IFR). Using the multivariate Engle-Granger Cointegration and Error correction mechanism (ECM) model, the study found that deposit interest rate and broad money supply have negative and positive long-run and short-run significant impacts on stock market returns respectively, whereas the impact of inflation rate  is insignificant in the long-run but significant in the short-run. The ECM result showed the right sign, indicating that stock market returns react to long-run monetary policy shocks by approximately 2% in two years. The study strongly recommends adoption and effective implementation of realistic expansionary monetary and fiscal policy measures to revamp the economy and improve stock market performance in Nigeria.