IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

How does Monetary Policy Influence Capital Markets? Using a Threshold Regression Model

  • Guan-Ru Chen

    ()

  • Ming-Hung Wu

    ()

Registered author(s):

    This study indicates that the effects of interest rate changes on stock prices could be twofold and that the net effect is determined by which effect is dominant. The study employs a threshold regression model to see if, before and after the central banks cut the interest rates, there is a nonlinear relation between interest rates and the stock index. Based on traditional economic theory, stock prices should be inversely related to interest rates. However, the present study finds that as interest rates start to increase or decrease, the stock index prices are significantly and positively related to the interest rates. The changes in interest rates affect stock indexes inversely only after interest rates have crossed a certain threshold. The inverse U-shaped relationship between interest rates and stock indexes differs from the traditional wisdom. It could make interest rates more valuable in forecasting stock indexes, and it holds implications for monetary policies of central banks. To avoid the spurious regression problem, this study uses a cointegration test and an error correction model to confirm the results from the threshold regression model and finds that there is a significant cointegration relationship before and after central banks cut interest rates. Copyright Springer Science+Business Media, LLC. 2013

    If 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.

    File URL: http://hdl.handle.net/10.1007/s10690-012-9157-9
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

    Article provided by Springer in its journal Asia-Pacific Financial Markets.

    Volume (Year): 20 (2013)
    Issue (Month): 1 (March)
    Pages: 31-47

    as
    in new window

    Handle: RePEc:kap:apfinm:v:20:y:2013:i:1:p:31-47
    Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=102851

    References listed on IDEAS
    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.:

    as in new window
    1. Schwert, G William, 1989. "Tests for Unit Roots: A Monte Carlo Investigation," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(2), pages 147-59, April.
    2. Robert J. Shiller, 1988. "Causes of changing financial market volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 1-32.
    3. Ben S. Bernanke & Kenneth N. Kuttner, 2004. "What explains the stock market's reaction to Federal Reserve policy?," Finance and Economics Discussion Series 2004-16, Board of Governors of the Federal Reserve System (U.S.).
    4. Titman, Sheridan & Warga, Arthur, 1989. "Stock Returns as Predictors of Interest Rates and Inflation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(01), pages 47-58, March.
    5. 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.
    6. Asprem, Mads, 1989. "Stock prices, asset portfolios and macroeconomic variables in ten European countries," Journal of Banking & Finance, Elsevier, vol. 13(4-5), pages 589-612, September.
    7. Bruce E. Hansen, 1997. "Threshold effects in non-dynamic panels: Estimation, testing and inference," Boston College Working Papers in Economics 365, Boston College Department of Economics.
    8. Apergis, Nicholas & Eleftheriou, Sophia, 2002. "Interest rates, inflation, and stock prices: the case of the Athens Stock Exchange," Journal of Policy Modeling, Elsevier, vol. 24(3), pages 231-236, June.
    9. Troy Davig & Jeffrey R. Gerlach, 2006. "State-Dependent Stock Market Reactions to Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
    10. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
    11. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
    12. Bohl, Martin T. & Siklos, Pierre L. & Werner, Thomas, 2007. "Do central banks react to the stock market? The case of the Bundesbank," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 719-733, March.
    13. Bruce E. Hansen, 2000. "Sample Splitting and Threshold Estimation," Econometrica, Econometric Society, vol. 68(3), pages 575-604, May.
    14. Elyasiani, Elyas & Mansur, Iqbal, 1998. "Sensitivity of the bank stock returns distribution to changes in the level and volatility of interest rate: A GARCH-M model," Journal of Banking & Finance, Elsevier, vol. 22(5), pages 535-563, May.
    15. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
    16. James G. MacKinnon, 1995. "Numerical Distribution Functions for Unit Root and Cointegration Tests," Working Papers 918, Queen's University, Department of Economics.
    17. Bredin, Don & Hyde, Stuart & O'Reilly, Gerard, 2005. "European Monetary Policy Surprises: The Aggregate and Sectoral Stock Market Response," Research Technical Papers 10/RT/05, Central Bank of Ireland.
    18. Domian, Dale L & Gilster, John E & Louton, David A, 1996. "Expected Inflation, Interest Rates, and Stock Returns," The Financial Review, Eastern Finance Association, vol. 31(4), pages 809-30, November.
    19. Michael J. Fleming & Eli M. Remolona, 1997. "What moves the bond market?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 31-50.
    20. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September.
    21. Flannery, Mark J & James, Christopher M, 1984. " The Effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions," Journal of Finance, American Finance Association, vol. 39(4), pages 1141-53, September.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:kap:apfinm:v:20:y:2013:i:1:p:31-47. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Guenther Eichhorn)

    or (Christopher F. Baum)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.