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Interdependence between Monetary Policy and Stock Liquidity: A Panel VAR Approach

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  • Byomakesh Debata
  • Jitendra Mahakud

Abstract

This article examines the relationship between monetary policy and individual stock liquidity in an order-driven emerging stock market like India. This study considers stocks listed in National Stock Exchange of India (NSE) and continuously traded from April 2002 to March 2015. Considering the multiple dimensions of liquidity, this study uses five different liquidity proxies to capture the various facets of liquidity such as trading activity, price impact and transaction cost. An array of macroeconomic and firm-specific control variables are used while analysing the liquidity and monetary policy relationship. Econometric methods like panel vector autoregressive (VAR)–Granger causality test, impulse response functions and variance decomposition analysis have been employed to carry out this analysis. The empirical findings suggest that monetary policy significantly Granger-causes stock liquidity, and the expansionary monetary policy characterised by low interest rate and higher money supply is positively associated with individual stock liquidity in India. The impact of monetary policy on liquidity of individual stocks is more prominent during financial crisis. The findings of the present study have certain theoretical as well as practical implications. The market participants in equity market can improve the forecasting of liquidity of their investment portfolio by employing monetary policy along with individual asset’s characteristics. Regulators and policymakers may consider the cross-sectional relationship between stock liquidity and monetary policy as an important source of information for policy formulation and implementation. JEL Classification: E44, E51, G12

Suggested Citation

  • Byomakesh Debata & Jitendra Mahakud, 2018. "Interdependence between Monetary Policy and Stock Liquidity: A Panel VAR Approach," Margin: The Journal of Applied Economic Research, National Council of Applied Economic Research, vol. 12(4), pages 387-413, November.
    • Handle: RePEc:sae:mareco:v:12:y:2018:i:4:p:387-413
    DOI: 10.1177/0973801018786270
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    More about this item

    Keywords

    Order-driven Emerging stock market; Monetary policy; Stock liquidity; Vector Autoregressive (VAR) model; Granger causality; Impulse response function; Variance decomposition;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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