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The Effect of Equity Market Integration on the Transmission Monetary Policy. Evidence from Australia

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Abstract

This paper investigates the effects of equity market integration on the transmission of monetary policy shocks. Based on the assumption that financial market liberalization and integration lead to falling portfolio holding costs, we analyze its effect on a two-country DSGE model with staggered prices and endogenous portfolio choice under incomplete markets. The model predicts that the reaction of stock prices, output and RER becomes muted upon impact and less persistence with falling portfolio holding costs. To test for a similar pattern in the data, we estimate a VAR with rolling coefficients for Australia, which provides a good case study. We identify a monetary policy shock with the sign restriction approach. The impulse responses generated by the data are consistent with the prediction of the model and imply that equity market liberalization seems to weaken the impact of monetary policy, at least on stock prices.

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Paper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 03-2009.

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Length: 65
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:gii:giihei:heidwp03-2009

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Keywords: Endogenous portfolio; Monetary policy; Financial liberalization; FAVAR;

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