FINANCIAL DEREGULATION AND THE RELATIONSHIP BETWEEN THE ECONOMY AND THE SHARE MARKET IN AUSTRALIA by

In this paper we investigate the effect of financial deregulation on the relationship between the macroeconomy and the share market within the framework of a VAR using quarterly Australian data for three variables – aggregate share prices, real output and the term premium. After an analysis of stationarity and cointegration of the three variables, we specify the VAR in the first differences of the logs of share prices and output and the level of the term premium. Since financial deregulation took place in Australia over an extended period in the 1980s, we do not pre-specify a single break-point but use the Andrews (1993) test for structural stability of the model as a whole. We find a distinct break at 1982(3) which we argue is consistent with the effects of (the early stages of) financial deregulation which began in the late 1970s and continued throughout most of the 1980s. We go on to estimate and simulate the model separately over two sub-samples: 1970(3) – 1982(3) and 1982(4) 1999(1). We conclude that financial deregulation resulted in greater integration between the share market and the real part of the economy but, paradoxically, weakened the relationship between the share market and other financial markets.