Monetary shocks and asymmetric effects in an emerging stock market: The case of China

a r t i c l e i n f o JEL classification: C22 E44 F31 Keywords: Monetary shocks Asymmetric effects MSVAR–EGARCH In this paper, we study the effect of monetary shocks on the Chinese stock market over the period of 2005 to 2011 with the MSVAR–EGARCH model. The evidence suggests that Chinese monetary policies have significantly asymmetric effects on the stock market in different time periods and market cycles. The effects of shocks from interest rate and reserve rate vary across market cycles but effects from money supply and exchange rate do not. Empirical evidence from the non-linear model shows that monetary policy changes increase stock market volatility, even though these monetary policies are often aimed at stabilizing macroeconomic activities. The evidence suggests that both the market conditions and the effects on stock markets should be taken into consideration in monetary policy design and implementation. Over the past decade, monetary policy has increasingly become a frequently used tool in emerging economies due to the changes of international and domestic economic environment. The flexibility of monetary policy helps emerging economies deal with increasingly internal and external uncertainty. In particular, for those emerging markets experiencing high-speed growth in the past several years, monetary policy has been heavily used to adjust money supply, interest rate, exchange rate and required reserve rate to achieve the desired policy goals. In the meanwhile, due to their inherent characteristics and drawbacks , stock markets in emerging economies are more easily affected by the changes of government monetary policies than in mature markets. This gives rise to an impact of government policies on the volatility of stocks that is as big as, if not bigger than, the impact of the intrinsic value on the volatility of stocks in the emerging markets. Traditional economic theory suggests a relationship between the stock market performance and information (e.g., Fama et al., 1969; Mitchell and Mulherin, 1994). Shocks from changes of monetary policy have been shown to be one of the most important pieces of information in the stock market and affect the stock market through the " Wealth Effect " , " Liquidity Effect " and " Market Channel Effect " While monetary policy is designed to impact the macro-economy, those policies, as monetary shocks, also affect the stock market indirectly. Moreover, these impacts on the stock market are significantly different during different time periods and market cycles. In some …