Monetary shocks and stock returns in an emerging market : a VAR analysis

The present paper analyzes the stock prices - money supply interactions in a five-variable framework, which includes, in addition to the two focal variables, real industrial production, aggregate price level, and exchange rate. The dynamic interactions among the variables are based on variance decompositions and impulse-response functions generated from the VAR. Using monthly data from 1977.1-1997.6, we document findings suggestive of the dominant influence of monetary variables on the stock price movements. In particular, the evidence seems to indicate a unidirectional causality from money to stock prices with money exerting a temporary wealth effect on the stock prices. Additionally, we find (a) a positive stock price - consumer price link; (b) a pro-cyclical monetary policy, and (c) an exchange rate stabilization of monetary policy. The inclusion of the crisis years (1997.7-1998.8) does not seem to affect these basic results. Indeed, it only intensifies the extent to which economic shocks affect stock price movements and makes the effects of exchange rate on other variables more pronounced. (Sav Dev/DÜI)