HOW DOES THE CANADIAN STOCK MARKET REACT TO THE FED'S POLICY?

This study examines how the Canadian stock market reacts to the Fed’s policy. Although many research studies have measured the bilateral correlation among national stock markets, rarely have they investigated this correlation within a Free Trade Zone (FTZ). We use a Vector Error Correction Model (VECM) accounting for monetary and exchange rate policies to measure the long-term elasticity of Toronto Stock Exchange (TSE) not only to the Fed’s policy, through the movements of Federal Fund Rate (FFR), but also to the parity value of the Canadian-U.S. dollar exchange rate. The estimated results suggest that TSE is sensitive to both FFR, and the conversion rate of the US-Canadian dollar. The variance decomposition technique helps us to determine the main factors contributing to the movements of TSE. We also use multivariate dynamic forecasts to predict TSE.