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Do Interest Rates Really Affect the Stock Market?

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Term Project Report

Do Interest Rates Really Affect the Stock Market?

TABLE OF CONTENTS

BACKGROUND 1

REGRESSION ANALYSIS 3

CONCLUSION 5

REFERENCES 6

APPENDIX A-1

BACKGROUND

It is generally believed that when interest rates increase there is an adverse affect on the stock market. This is due to the fact that, “makes borrowing money more expensive, which affects how consumers and businesses spend their money; increases expenses for companies, lowering earnings somewhat for those with debt to pay; and, finally, it tends to make the stock market a slightly less attractive place to investment.” (Mueller, 2006) The purpose of this project is to determine the effect of interest rates (INT) on the stock market (STOCKS) while holding constant the inflation rate (INFLATE), and the median yearly income (INCOME),. This study uses a time-series analysis with 31 annual observations from 1974 to 2004. All data will come from the following sources; stock data and interest rates come from www.economagic.com; data on inflation come from http://inflationdata.com; income data comes from the U.S. Census Bureau, www.census.gov. The model (less constants and coefficients) is:

STOCKS = INT + INFLATE + INCOME

The dependant variable, STOCKS, is defined as the average DOW Industrial Average for each year. This average is will be calculated by summing the closing DOW average at the end of each day for each year and then averaging them to come up with a corresponding yearly average. INT is will be a yearly average of the Federal Reserve Board’s discount rate, the rate that banks borrow funds from the government. This will be calculated by summing the interest rate for each month of a year and then dividing that sum by 12 to come up with a yearly average. This variable was chosen...

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