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The Asymmetric Effects of Monetary Policy on Stock Market (Job Market Paper)
This paper investigates the asymmetric effects of monetary policy on the U.S. stock market across different monetary policy regimes and stock market phases. In particular, it uses a Markov-switching dynamic factor model to generate a new composite measure that represents overall stock market movements, and to date the turning points of each bear market and bull market. A time-varying parameter analysis, which is undertaken in the framework of a state space model and estimated via Kalman Filter, is then used to study the contemporaneous and lead-lag effects of monetary policy on stock returns. The results provide evidence that major changes in monetary regimes and shifts in stock market conditions shape the time-varying relationship between monetary policy and stock returns. It is observed that the monetary policy of changing monetary aggregates is less effective in bear markets than bull markets, but changes in the federal funds rate can be more effective in bear markets. The results also indicate that increases in monetary aggregates or reductions in the federal funds rate have positive contemporary effects on stock performance only during periods in which they are used as the monetary policy target by the Federal Reserve.
This paper investigates the asymmetric effects of monetary policy on the U.S. stock market across different monetary policy regimes and stock market phases. In particular, it uses a Markov-switching dynamic factor model to generate a new composite measure that represents overall stock market movements, and to date the turning points of each bear market and bull market. A time-varying parameter analysis, which is undertaken in the framework of a state space model and estimated via Kalman Filter, is then used to study the contemporaneous and lead-lag effects of monetary policy on stock returns. The results provide evidence that major changes in monetary regimes and shifts in stock market conditions shape the time-varying relationship between monetary policy and stock returns. It is observed that the monetary policy of changing monetary aggregates is less effective in bear markets than bull markets, but changes in the federal funds rate can be more effective in bear markets. The results also indicate that increases in monetary aggregates or reductions in the federal funds rate have positive contemporary effects on stock performance only during periods in which they are used as the monetary policy target by the Federal Reserve.
Nonlinear Relationship between Monetary Policy and Stock Returns: A Joint Markov-Switching Dynamic Bi-Factor Approach
This paper proposes an econometric model to investigate the joint dynamic interrelationship between the monetary policy of the Federal Reserve and the U.S. stock market performance. Using a Markov-switching dynamic factor model, the paper extracts a latent factor from several monetary and credit variables to represent changes in the monetary policy. It also uses a second latent factor to represent the stock market, constructed using major stock market indices. These two unobserved factors are estimated simultaneously in a joint nonlinear econometric model from the observable variables and from their relationship with each other, but they are allowed to follow different two-state Markov-switching process. The unobserved factors are set in the framework of a bivariate vector autoregression to examine the dynamic relationship between stock market phases and monetary policy regimes. The results indicate a significant correlation between the monetary policy phases and stock market regimes.
This paper proposes an econometric model to investigate the joint dynamic interrelationship between the monetary policy of the Federal Reserve and the U.S. stock market performance. Using a Markov-switching dynamic factor model, the paper extracts a latent factor from several monetary and credit variables to represent changes in the monetary policy. It also uses a second latent factor to represent the stock market, constructed using major stock market indices. These two unobserved factors are estimated simultaneously in a joint nonlinear econometric model from the observable variables and from their relationship with each other, but they are allowed to follow different two-state Markov-switching process. The unobserved factors are set in the framework of a bivariate vector autoregression to examine the dynamic relationship between stock market phases and monetary policy regimes. The results indicate a significant correlation between the monetary policy phases and stock market regimes.
A Vector Error Correction Model of the Foreign Exchange Reserve Accumulation
This paper investigates the long-run and short-run relationship among foreign exchange reserve, money supply and exchange rate, under the monetary policy of exchange rate targeting. Hong Kong maintains currency board monetary policy and serves as a good example. This study discusses the benefits and costs of foreign exchange reserve accumulation. Empirical approaches such as cointegration test, Granger Causality test, and Vector Error Correction Model (VECM) are employed in the paper. The results show a positive long-run relationship between broad money supply and foreign exchange reserve holding, and no significant long-run relationship between exchange rate and foreign exchange reserve holding, which is consistent with the theoretical model (Obstfeld, Shambaugh, and Taylor 2010). The VECM results indicate a low speed of adjustment of the foreign exchange reserve of its departure from the long-run equilibrium, providing another reason for the large amount of foreign exchange reserves held by the central bank.
This paper investigates the long-run and short-run relationship among foreign exchange reserve, money supply and exchange rate, under the monetary policy of exchange rate targeting. Hong Kong maintains currency board monetary policy and serves as a good example. This study discusses the benefits and costs of foreign exchange reserve accumulation. Empirical approaches such as cointegration test, Granger Causality test, and Vector Error Correction Model (VECM) are employed in the paper. The results show a positive long-run relationship between broad money supply and foreign exchange reserve holding, and no significant long-run relationship between exchange rate and foreign exchange reserve holding, which is consistent with the theoretical model (Obstfeld, Shambaugh, and Taylor 2010). The VECM results indicate a low speed of adjustment of the foreign exchange reserve of its departure from the long-run equilibrium, providing another reason for the large amount of foreign exchange reserves held by the central bank.