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Response of Stock Markets to Monetary Policy: The Tehran Stock Market Perspective

2014; Routledge; Volume: 13; Issue: 3 Linguagem: Inglês

10.1080/15339114.2014.985458

2150-5403

Naoyuki Yoshino, Farhad Taghizadeh–Hesary, Ali Hassanzadeh, Ahmad Danu Prasetyo,

Islamic Finance and Banking Studies

AbstractThe article assesses the response of Tehran stock prices to exogenous monetary policy shocks, using a vector error correction model for the 1998Q1–2013Q2 period. Monetary policy is transmitted to stock market price through three routes: money by itself, exchange rate and inflation. Our result in this paper points to the fact that stock prices increase persistently in response to an exogenous easing monetary policy. Variance deposition results show that, after ten periods, the forecast error variance of more than 53 per cent of the Tehran Stock Exchange Price Index (TEPIX) can be explained by the exogenous shocks to the US dollar–Iranian rial exchange rate, while this ratio for exogenous shocks to the Iranian real gross domestic product was only 17 per cent. The article argues that such evidence can be accounted for by an endogenous response of the stock prices to the monetary policy shocks.Keywords: Tehran stock exchangemonetary policyAsian stock marketsmodelling the stock pricesvector error correction model (VECM) AcknowledgementsWe would like to thank Professor Masao Ogaki, Professor Colin McKenzie and all participants of the Public Economics Seminar at Keio University, who provided us with valuable suggestions and comments to improve this paper.About the AuthorsNaoyuki Yoshino is Dean of the Asian Development Bank Institute (ADBI) and Professor Emeritus of Keio University, both in Tokyo, Japan. He obtained his PhD from Johns Hopkins University in 1979. He was Director of the Financial Services Agency's (FSA) Financial Research Center (FSA Institute) of the Government of Japan from 2004 until 2014 and is now the Chief Advisor. He was nominated for inclusion in Who's Who in the World, 2009 and 2013. He obtained honorary doctorates from the University of Gothenburg (Sweden) in 2004 and Martin Luther University of Halle-Wittenberg (Germany) in 2013. He also received the Fukuzawa Award in 2013 for his contribution to research on economic policy.Farhad Taghizadeh-Hesary is a Researcher of Economics at the School of Economics, Keio University, Tokyo, Japan. He also serves as a Visiting Scholar at the Institute of Energy Economics of Japan (IEEJ). He is pursuing his PhD degree at the Graduate School of Economics, Keio University, under the supervision of Professor Naoyuki Yoshino, and also assists Professor Yoshino in his capacity as Dean of the Asian Development Bank Institute. His major research interests lie in the areas of monetary economics, banking, finance and energy economics.Ali Hassanzadeh is Associate Professor and a faculty member of the Monetary and Banking Research Institute (MBRI) of the Central Bank of Iran in Tehran, Iran. He is also the CEO of Kavosh Research Company, which is a subsidiary of Mellat Financial Group. He has a PhD degree in Economics and his major research interests lie in the areas of economics, banking, risk and insurance management and financial management.Ahmad Danu Prasetyo is a member of the academic staff at the School of Business and Management, Bandung Institute of Technology (SBM ITB), Bandung, Indonesia. He obtained his Bachelor degree in Industrial Engineering from Telkom Institute of Technology, Indonesia and a Master of Science degree in Management from Bandung Institute of Technology, Indonesia. He is currently pursuing his PhD degree at the Graduate School of Economics, Keio University, Japan. He has served in the Ministry of Finance, Republic of Indonesia as a consultant for government bond market development in various projects. He has a wide range of research interest in economics and finance.Notes1 Straits Times Index (STI) is a capitalization-weighted stock market index that is regarded as the benchmark index for the Singapore stock market. It tracks the performance of the top 30 companies listed on the Singapore Exchange. It is jointly calculated by Singapore Press Holdings (SPH), Singapore Exchange (SGX) and FTSE Group (FTSE).2 In order to show that the base of most of stock pricing models is DPV, here we explain how this applies for CAPM:Assuming that Model (1) shows the price of any individual risky asset in the market, the expected return on any individual risky asset after n periods will be:(a) where E[Ri]t+n is the expected return on an individual risky asset after n periods, E[Pi]t+n is the expected price of an individual risky asset after n periods and [Pi]t is the present market price of an individual risky asset.In order to get the expected return on the market portfolio, we average over equation (a), which results in:(b) where E[Rm]t+n is the expected return on the market portfolio after n periods and the expected "average" return from holding all assets in the optimal proportions, and E[Pm]t+n is the expected market portfolio price after n periods.Equations (a) and (b) help us to obtain the following variance and covariance, which are needed to release CAPM:We know that: var(X) = E[X – E(X)]2 = E(X2) – (E(X))2, and cov(X,Y) = E[(X – E[X])(Y – E[Y])]Thus(c) (d) Since the actual returns on the market portfolio differ from the expected returns, the term (Rm–E[Rm])t+n on the market portfolio is non-zero. CAPM predicts that the expected excess return on an individual risky asset (E[Ri]–r)t+n is directly related to the expected excess return on the market portfolio (E[Rm]–r)t+n, with the constant of proportionality given by the beta of the individual risky asset (Cuthbertson & Nitzsche, Citation2003):(e) where βi = [cov(Ri,Rm)/var(Rm)]t+n (r is the return from risk-free asset, e.g. fixed-term bank deposit or government bond). The explanations above show how DPV is the base of CAPM.3 In this study, using the interest rate is not practical since Iran has implemented Islamic banking rules, which are quite different from the conventional rules. Interest rates are affected by monetary policy. Hence, instead of the real interest rate, we choose another monetary variable, i.e. monetary base, which has a high correlation with the interest rate, as shown in many earlier studies.4 The former governor of the Central Bank of Iran was Mahmoud Bahmani (in office 2 September 2008–2 September 2013) and the new governor is Dr Valiollah Seif.5 The results of this paper imply that there are signs of a bubble in the Tehran stock market. For more information about the causes of the bubble and bubble indicators, and to answer the question of why bubbles occur in many countries, see Yoshino, Nakamura, and Sakai (Citation2013).6 The Taylor rule is as follows:where r is short-term interest rate (e.g., the federal fund rate in the United States or call rate in Japan), is the rate of inflation, is the desired rate of inflation, y is real GDP and y f is GDP in full employment.7 When the economy looks like it is in a bubble, monetary authorities have to look at asset prices, stock prices and the exchange rate market, and not only at inflation and the GDP gap, so the extended version of the above equation is as follows:where is the stock price index growth rate, e is the nominal exchange rate and is the desired nominal exchange rate level.