On the Relationship between Monetary Policy Instruments, Macroeconomic Variables and Stock Market Returns

The purpose of this paper is to study the impact of the monetary policy instruments and to explore the extent to which macroeconomic variables affect the Romanian stock market’s behaviour in the 2000 – 2011 period with a GARCH-family system of simultaneous equations. Another rational of this research is to determine whether stocks are a good hedge against inflation on the Romanian financial market. To derive a testable model of the relationship between Romanian stock returns and selected macroeconomic variables, we formulate a multifactor model – both in a lead-lag and a contemporary setting as follows: S = f (PR, REER, MM, TB, I, UnE) where: S is the monthly stock index return, PR represents the principal rate quoted in units of National Currency per SDR, REER is the Real effective Exchange Rate based on relative consumer prices, MM denotes the Money Market Rate, TB stands for the Treasury Bill Rate (91 days), I is the CPI % change and UnE represents the Unemployment Rate. Results reveal that when interest rates rise, the investors on the Romanian stock market will move away from stocks, thereby decreasing stock prices. In addition, other results suggest that the real effective exchange rate seems to be a suitable target for the government to focus on in order to stabilize the Romanian stock exchange and to encourage the entrance of more capital flows into the market. Finally, we can report that stock are not a good hedge against inflation on the Romanian market, as an increase in the rate of inflation has a significant negative impact on next-month stock returns. Key-Words: macroeconomic variables, monetary policy, Romanian stock market, simultaneous