IMPACT OF MONETARY POLICY ON STOCK PRICES IN NIGERIA
ABSTRACT
    The study empirically investigates the impact of monetary policy on stock prices in Nigeria. The direction of research was to empirically determine the main impact of certain monetary policy indicators on stock price movement. Using data covering the period 1985 to 2013, econometric tools of correlation and ordinary least squared (OLS) were employed to estimate the empirical relationships.
    Based on the empirical investigation, the specific findings show that inflation rate has a weak negative impact on stock prices in Nigeria; interest rate has a weak negative effect on stock prices; money supply has a pervasive weak positive impact stock prices in Nigeria; that exchange rate has no impact on stock prices in Nigeria, and that the past values of stock prices (SP) have a significant relationship with     monetary policy issues in Nigeria than the current values.  
    The study recommends among others that an appropriate policy that will minimize or ensure a favourable interest rate should be pursued vigorously by the country’s monetary authority in this regard. Also, in order to stabilize prices, monetary authorities should seek to regulate and increase the volume of money in circulation so that people will have more money to invest and thus boost the overall economic growth in the country.
TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION
Background to Study                    
1. 2    Statement of the Research Problem                
1.3    Objective of the Study                    
1.4    Hypothesis of the Study            
1.5    Significance of the Study        
1.6    Scope of the Study                
1.7    Limitation of the Study                
CHAPTER TWO: LITERATURE REVIEW
2.1    Introduction                    
2.2    Monetary Policy and Stock Market Activity    
2.3    Monetary Policy and Exchange Rates        
2.4    Money Supply and Stock Prices        
2.5    Exchange Rate and Stock Prices            
2.6    Inflation Rate and Stock Prices            
2.7    Interest Rate and Stock Prices            
2.8    Empirical Evidence around the World        
CHAPTER THREE: METHODOLOGY
3.1    Introduction                    
3.2    Model Specification                    
3.3    Estimation Technique                
3.4    Sources of Data                        
3.5    Operationalization of Variables    
    CHAPTER FOUR: EMPIRICAL ANALYSIS
4.1    Introductions                    
4.2     Correlation Analysis                
4.3    Regression Analysis                
4.4    Policy   Implications                    
CHAPTER FIVE: SUMMARY OF FINDINGS, RECOMMENDATIONS AND CONCLUSION
5.1     Summary of Findings                
5.2     Conclusion                        
5.3     Recommendations                    References                             
    Appendix                         
CHAPTER ONE
INTRODUCTION
1.1    BACKGROUND TO THE STUDY
    The Nigerian economy, since independence has undergone several rudimental changes in terms of the appropriate macroeconomic policies targeted at achieving the objectives of stable prices, full employment and aggregate growth. The two major policy switches experienced or experimented in the management of the Nigerian economy so far are the monetary and the Keynesian economic approaches. Monetary Policy refers to the specific actions taken by the Central Bank (Monetary Authority) to regulate the value, supply and cost of money in the economy with a view to achieving predetermine macroeconomic goals. The Central Bank of Nigeria, like other central banks in developing countries, seeks to achieve price stability through the management of money supply. On the other hand, the Keynesian or Fiscal policy deals with government deliberate actions in spending money and levying taxes with a view to influencing macro-economic variables in a desired direction. This includes sustainable economic growth, high employment creation and low inflation (Microsoft Corporation, 2004).
    In economic theory, there is a strong link between monetary policy and stock prices. This is true because any development from monetary policy has a direct or indirect impact on the value of current stock prices in the stock market and hence, the overall value of the firms issuing the stocks. The effect of monetary policy on equity prices and interest rates is relevant to several possible transmission mechanisms from central bank actions to the real economy. For example, the Central Bank of Nigeria controls the federal funds rate, which purportedly affects market-determined interest rates and asset prices and, in turn, real variables through various possible investment and consumption channels.
    According to Thabelo (2012), investors need to know how monetary policy affects the performance of stock markets in order to be able to accurately measure the intrinsic value of stock. From a fundamentalist point of view, making profits from stock trading depends on an investor’s ability to accurately calculate stock’s intrinsic value. This is done by examining the environment of the firm; related economic, financial and other qualitative and quantitative factors. Only then can the investor compare the stock’s intrinsic value with its current market price and decide whether the stock is overpriced or underpriced. An overpriced stock would be the one that the intrinsic value is below the market price, while the reverse is true for the underpriced stock. Rational investors would buy underpriced stock, with the hope that the stock market price will rise to its intrinsic value thus making a profit from the spread. Inversely, rational investors would sell over-priced stock because they would be expected to fall in price towards their intrinsic value (Thabelo, 2012).
1.2    STATEMENT OF THE RESEARCH PROBLEM
    The recent financial crisis has been characterized by unprecedented monetary policy interventions of central banks all over the world with the intention to stabilize financial markets and the real economy. Financial market liquidity is a necessary precondition for a well-functioning and efficient stock market. Liquidity according to Amihud et al. (2005) is the ease of trading in the stock markets; adding that stock returns are an increasing function of illiquidity, and numerous studies investigated the relationship between liquidity and asset returns. The empirical literature on the relationship between liquidity and stock returns generally confirms the theoretical proposition that required returns are an increasing function of illiquidity (Chordia et al. 2005).
    For instance, the study of Amador, et. al (2009) empirically examine the impact of monetary policy on stock liquidity and thereby addresses its role as a determinant of commonality in liquidity. To capture effects both at the micro and macro level of stock markets, they apply panel estimations and vector autoregressive models. The results from the empirical analysis suggest that an expansionary monetary policy of the European Central Bank (ECB) leads to an increase of stock market liquidity in the German, French and Italian markets. These findings are robust for seven proxies of liquidity and two measures of monetary policy. Chordia et al. (2005) and Goyenko & Ukhov (2009) on the other hand, submitted that monetary policy determines liquidity through its impact on return volatility, interest rates and asset prices.
    The intuition behind these findings is that investors demand higher gross returns as compensation for holding less liquid stocks. Another well-established strand of the academic literature on asset liquidity documents that the liquidity of individual stocks exhibits significant co-movement, which is usually referred to as commonality in liquidity. Covariation in the liquidity of stocks implies that the risk of illiquidity cannot be diversified and therefore illiquidity should be regarded as a systematic risk factor. Furthermore, the observed commonality in liquidity leads to the conclusion that there needs to be at least one common factor that simultaneously determines the liquidity of all stocks in a market Goyenko and Ukhov (2009). Thus, in a nut-shell, the issue of liquidity is therefore a function of monetary policy direction of the country overtime with respect to the stock market.
    Hence, this study within the Nigerian context, seeks to empirically assess the relative impact of the Nigerian monetary policy on stock prices over the years, by providing answers to the following research questions:
(i)    What is the relationship between money supply and stock prices in the Nigerian stock market?
(ii)    Does exchange rate have any positive impact on stock prices in the Nigerian     stock market?
(iii)    What is the impact of inflation rate on stock prices in Nigeria?
(iv)    Is there any positive relationship between interest rate and stock prices in the     Nigerian stock market?
1.3    OBJECTIVE OF THE STUDY
    The main objective of the study is to determine the effect of monetary policy on stock prices in Nigeria. However, other sub objectives are to:
Determine the relationship between money supply and stock prices in Nigeria.
Examine the impact of exchange rate on stock prices in Nigeria.
Assess the impact of inflation rate on stock prices in Nigeria.
Determine the relationship between interest rate and stock prices in the Nigerian stock market.
1.4       HYPOTHESES OF THE STUDY
    The following are the hypotheses to be tested in the study:
Money supply has no significant effect on stock prices in Nigeria.
Exchange rate has no significant impact on stock prices in Nigeria.
There is no positive relationship between inflation rate and stock prices.
Interest rate does not have positive effect on stock prices in the Nigerian stock market.
1.5    SIGNIFICANCE OF THE STUDY
    The study is significant in the following respect:
Firstly, the results from the study will provide relevant data to the government and policy makers with respect to the effective and efficient management of the monetary policy issues affecting the nation’s stock market, which will in turn engender the overall growth of the Nigerian economy.
    Secondly, investors, potential investors, lenders and borrowers and all stakeholders in the Nigerian stock market are all interested in the monetary policy- stock prices direction in the country and hence, enable them to make some inform decisions with respect to investment and financing decisions.
     Furthermore, the study will also be relevant to researchers, academia, students of finance and allied disciplines, as it will provide them relevant data to carry out further studies in this area or similar areas if they so wish.
1.6    SCOPE OF THE STUDY
    The study is restricted to all quoted firms in the Nigerian capital market. It covers a period of twenty nine years (1985 to 2013), and relevant data shall be sourced from the Central Bank of Nigeria Statistical Bulletin (2013) and the Nigerian Stock Exchange Fact Files and the Bureau of Federal statistics.
1.7    LIMITATION OF THE STUDY
    The two limitations envisage in this study has to do with the accuracy of the data used as well as the sources of data. However, effort will be made to minimize errors and thus assure the reliability of results obtained.