I ran an empirical analysis on recent interest rate changes of European central banks on Swiss equity prices and found statistically significant results. A 1 percentage point increase in interest rates would lead to a around 5% increase in the daily return of equities on the day the monetary policy announcement was made. For bond prices my results show that this would lead to a negative impact on bond prices of about 1%, which is what I would have expected for equities too. So how can it be that the short term response of equity prices to a rise in interest rates is positive?
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2 Answers
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Stock market is very complicated and there are many factors in play other than interest rates.
For example, let's say the word on the street is that the Fed is going to increase interest rates by 50 basis points at its next meeting, but the Fed announces a increase of only 25 basis points. The news may actually cause stocks to increase – because assumptions of a 50 basis point increase had already been priced into the market.
Interest rate hikes typically occur during favourable economic conditions (inflation control) which move the stock prices up instead of decreasing.
It is very difficult to understand the correlation between interest rates and stock prices, as many of them might positively correlated like stocks of banks, insurance etc
Under Portfolio theory, investors are compensated for systematic risk only because unsystematic risk can be diversified. Interest rates hike is a systematic risk and investor must be rewarded (return) for that additional risk. Mathematically, I think it shifts the security market line (SML) upward.
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$\begingroup$ It cannot be the first point since I was looking at the unexpected interest rate change using a jump in the interest rate future to determine whether the change was expected or not. I think 2. makes the most sense $\endgroup$– Elias K.Commented May 22, 2021 at 11:34
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perhaps flight to quality? ie reduced expectations of euro equity profits cause equity reallocation out of euro into chf.
and increased eur bond yields perhaps cause bonds reallocation out of chf into eur because of a) higher , ie more attractive coupons , b) eurchf xchange rate perhaps expected to strengthen
