Monetary policy shocks and stock market volatility in emerging markets

Abstract

This paper examines the effect of monetary policy decisions on stock markets in emerging economies particularly South Africa for the period 2000Q1 to 2016Q4. This is important as the monetary authorities would understand how their decisions may cause reactions to the stock market. Monetary policy directly shocks money supply and repo rate and indirectly GDP and inflation among many macroeconomic variables. A hypothesis that stock markets do not respond to monetary policy determinations is formulated and tested using a two-stage approach by employing first the vector error correction model to determine the long-run relationship of the variables and secondly GARCH (1, 2) model to determine the volatility. And the results suggest that about 5.2% variations in the Johannesburg Stock Exchange (JSE) volatility are due to monetary policy shocks. Overall, there is a negative relationship between M2 and stock market volatility. However, there is a positive link between repo rate and JSE volatility, which is not economically preferable because variations in repo rate influence the aggregate demand of investment on securities. The study recommends that the Monetary Policy Committee an expansionary monetary policy of keeping the repo rate lower must be pursued in order to increase borrowing that makes the public to have money to make transactions in securities on the financial market.