This paper applies standard vector autoregressions (VAR) technique to quarterly data for Botswana for the period 1993-2010 to investigate the impact of monetary policy shocks on stock returns. Monetary policy is measured by changes in the 91 day Bank of Botswana Certificates rate. Our results indicate that positive interest rate innovations are associated with increases, rather than decreases, in the aggregate stock returns of companies listed on the Botswana Stock Exchange (BSE). A possible explanation for this counter-intuitive result is that the market capitalization in BSE is dominated by commercial banks, which are also the main beneficiaries of the interest income from investment in risk-free Bank of Botswana Certificates. The observed positive reaction of aggregate stock returns to monetary policy tightening suggests that the increase in returns to bank stocks offsets the negative reactions of non-bank stock returns. Variance decomposition shows that monetary policy shocks explain a relatively small proportion of stock returns variability.

 

Keywords: Monetary policy; stock returns; vector autoregressions, Botswana