Market Reactions to Central Bank Interest Rate Changes: Evidence from the Chinese Stock Market*

Abstract

Abstract Contrary to theoretical expectations and empirical evidence in developed markets, the Chinese stock market reacts positively (negatively) to interest rate increases (cuts) by the central bank. During the period from January 1996 to December 2016, the Shanghai Composite Index had an average abnormal return of 1.07% (−1.85%) in reaction to interest rate increases (cuts) over the two‐day announcement window. We further demonstrate that short‐term market reactions are transitory and have no permanent effect. Finally, we reveal that short‐term market reactions cannot be explained by market frictions or information uncertainty. Rather, such reactions are likely driven by investor sentiment.