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The Nexus of Capital Flows, Real Interest Rate and Stock Price Performance: Evidence from Malaysia

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The stock market is widely known as an essential market in fostering capital formation to sustain economic growth. Higher levels of internationalisation of the stock market will lead to a positive economic growth in the country. The growth of stock market is of vital importance to Malaysia, an emerging economy, in the process of transforming its economic structure into a high-income-and-high-growth economy and thus realising its Vision 2020 of becoming a developed nation. Using VAR model of Johansen-Juselius multivariate cointegration procedures and multivariate Granger-Causality test, this paper examines both short-run dynamic and long-run relationship between the capital flows, both short term and long term, and stock performance in the presence of changes in real interest rate in Malaysia. Our empirical result denotes that there is a negative relationship between stock price and real interest rate in the long run. Besides, it is also found that the stock price is positively related to the net portfolio investment and private long-term investment. There is strong evidence of a bi-directional short-run causality between stock price and real interest rate as well as real interest rate and portfolio investment flows in Malaysia. This suggests that the stability in the stock market is closely linked to the interest rate stability. The fluctuation in real interest rate creates uncertainty for investors and hence affecting the capital flows into Malaysia and investors’ decision making in Malaysian stock market. It is therefore recommended that a forward-looking monetary policy is the necessity for economic stability as well as strengthening the functionality of stock market, which is fundamental for a country to reach high growth and high income by Year 2020.
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Keywords: Capital Flows; Granger Causality Test; Multivariate Cointegration Method; Real Interest Rate; Stock Price

Document Type: Research Article

Affiliations: 1: Faculty of Accounting, Finance and Business, Tunku Abdul Rahman University College, Malaysia 2: Faculty of Management, Multimedia University, Malaysia

Publication date: April 1, 2017

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