An Empirical Investigation of the Causal Relationship among Monetary Variables and Equity Market Returns
AbstractThis study explores the long-term dynamic relationship between equity prices and monetary variables for the period June 1998 to June 2008. Monetary variables include money supply, treasury bill rates, foreign exchange rates, and the consumer price index. The data have been examined using multivariate cointegration analysis and Granger causality analysis. Johansen and Juselius’ multivariate cointegration analysis indicates the presence of a long-term dynamic relationship between the equity market and monetary variables. Unidirectional Granger causality is found between monetary variables and the equity market. In the case of money supply, a positive relationship supports the liquidity hypothesis. Impulse response analysis indicates that the interest rate shock has a negative impact on equity returns in the Pakistani equity market. Exchange rates also have a negative impact on equity returns in the short run. However inflation has little impact on returns in the equity market. Variance decomposition analysis suggests that the interest rate, exchange rate, and money supply shocks are a substantial source of volatility for equity returns. The contribution of a monetary shock to the equity returns ranges from 4% to 16% over differenttime lags. Similarly, the VECM also confirms the presence of a short-term relationship between monetary variables and equity returns. This state of affairs demands that monetary variables be considered an important factor in determining stock market movements. Policymakers should be morevigilant and careful in designing monetary policies as it has a direct impact on cash inflows into the capital market and on the stability of the capital market.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Department of Economics, The Lahore School of Economics in its journal Lahore Journal of Economics.
Volume (Year): 14 (2009)
Issue (Month): 1 (Jan-Jun)
Contact details of provider:
Postal: Intersection Main Boulevard Phase VI DHA and Burki Road, Lahore
Phone: (92-42) 6560939
Web page: http://www.lahoreschoolofeconomics.edu.pk/EconomicsJournal/LJEIntro.aspx
More information through EDIRC
Monetary variables; equity; causality; Pakistan.;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
- Granger, C. W. J., 1988. "Some recent development in a concept of causality," Journal of Econometrics, Elsevier, vol. 39(1-2), pages 199-211.
- Kraft, John & Kraft, Arthur, 1977. "Determinants of Common Stock Prices: A Time Series Analysis," Journal of Finance, American Finance Association, vol. 32(2), pages 417-25, May.
- Naeem Muhammad & Abdul Rasheed, 2002. "Stock Prices and Exchange Rates: Are they Related? Evidence from South Asian Countries," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 41(4), pages 535-550.
- Mukherjee, Tarun K & Naka, Atsuyuki, 1995. "Dynamic Relations between Macroeconomic Variables and the Japanese Stock Market: An Application of a Vector Error Correction Model," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 18(2), pages 223-37, Summer.
- Johansen, S., 1991.
"Determination of Cointegration Rank in the Presence of a Linear Trend,"
76a, Helsinki - Department of Economics.
- Johansen, Soren, 1992. "Determination of Cointegration Rank in the Presence of a Linear Trend," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 383-97, August.
- Solnik, Bruno, 1987. " Using Financial Prices to Test Exchange Rate Models: A Note," Journal of Finance, American Finance Association, vol. 42(1), pages 141-49, March.
- Jones, Charles M & Kaul, Gautam, 1996. " Oil and the Stock Markets," Journal of Finance, American Finance Association, vol. 51(2), pages 463-91, June.
- Burmeister, Edwin & Wall, Kent D, 1986. "The Arbitrage Pricing Theo;ry and Macroeconomic Factor Measures," The Financial Review, Eastern Finance Association, vol. 21(1), pages 1-20, February.
- Zhou, Guofu, 1999. "Security factors as linear combinations of economic variables," Journal of Financial Markets, Elsevier, vol. 2(4), pages 403-432, November.
- Robert H. DeFina, 1991. "Does inflation depress the stock market?," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-12.
- Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
- Beenstock, Michael & Chan, Kam-Fai, 1988. "Economic Forces in the London Stock Market," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 50(1), pages 27-39, February.
- Roll, Richard & Ross, Stephen A, 1980. " An Empirical Investigation of the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 35(5), pages 1073-1103, December.
- Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
- Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
- Chan, K. C. & Chen, Nai-fu & Hsieh, David A., 1985. "An exploratory investigation of the firm size effect," Journal of Financial Economics, Elsevier, vol. 14(3), pages 451-471, September.
- Jaffe, Jeffrey F & Mandelker, Gershon, 1976. "The "Fisher Effect" for Risky Assets: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 31(2), pages 447-58, May.
- Chang, Eric C. & Pinegar, J. Michael, 1990. "Stock Market Seasonals and Prespecified Multifactor Pricing Relations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(04), pages 517-533, December.
- Burmeister, Edwin & McElroy, Marjorie B, 1988. " Joint Estimation of Factor Sensitivities and Risk Premia for the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 43(3), pages 721-33, July.
- Nelson, Charles R, 1976. "Inflation and Rates of Return on Common Stocks," Journal of Finance, American Finance Association, vol. 31(2), pages 471-83, May.
- Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
- Hamburger, Michael J & Kochin, Levis A, 1972. "Money and Stock Prices: The Channels of Influence," Journal of Finance, American Finance Association, vol. 27(2), pages 231-49, May.
- Mohammed Nishat & Rozina Shaheen, 2004. "Macroeconomic Factors and Pakistani Equity Market," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 43(4), pages 619-637.
- Maysami, Ramin Cooper & Koh, Tiong Sim, 2000. "A vector error correction model of the Singapore stock market," International Review of Economics & Finance, Elsevier, vol. 9(1), pages 79-96, February.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Shahid Salahuddin).
If references are entirely missing, you can add them using this form.