A Moving Window Analysis of the Granger Causal Relationship Between Money and Stock Returns

The purpose of this paper is to empirically examine whether movements in two important measurements of the aggregates money supply, M1 and M2, help in predicting future movements in the stock market. We use single-equation multivariate autoregressive models, with the optimal lag order selected using the Akaike Information Criterion, and run two types of Granger causality tests across sequences of moving windows of fixed length. The rolling window estimation results indicate that there is a good deal of instability in the lag order of these models when the federal funds rate is used as one of the conditioning variables. The causality test results suggest a rather strong causal link from money to stock prices once data from the 1960’s and early-to-mid 1970’s are excluded. The evidence in favor of causality from M2 to stock prices is much weaker. Our results suggest caution may be warranted in interpreting “full sample” results on the Granger-causal relationship between money and stock prices. ___________________________________________________________________________ I am grateful to Dr. Philip Rothman for very helpful direction and valuable comments on this paper.