THE IMPACT OF MONETARY POLICY ON FINANCIAL MARKETS: A STUDY OF THE EFFECTS OF INTEREST RATE CHANGES ON STOCK PRICES AND BOND YIELDS

Abstract

This study examines the impact of monetary policy decisions on financial markets in Pakistan between 2010 and 2023, focusing specifically on the relationship  between interest rate changes implemented by the State Bank of Pakistan and subsequent movements in stock prices and bond yields. Using a mixed-methods approach combining event study analysis, regression modeling, vector autoregression, and expert interviews, the research quantifies the transmission mechanisms from policy changes to market outcomes while accounting for Pakistan's unique economic context. The findings reveal significant negative relationships between policy rate increases and stock market returns, with a one percentage point rate increase associated with a 3.17% decline in the KSE-100 index. Bond yields demonstrated even stronger positive relationships with policy changes, with monetary policy explaining up to 68.54% of variance in government bond yields. The results further indicate that market reactions intensify over extended windows following announcements, suggesting gradual information processing and complex transmission channels. Expert perspectives highlight the role of institutional development, information asymmetries, and foreign investor sentiment in shaping Pakistan's monetary policy transmission. These findings contribute to understanding monetary policy effectiveness in emerging economies and provide actionable insights for policymakers seeking to balance macroeconomic objectives with financial market stability.