1. THE STOCK MARKET AND THE MONEY SUPPLY Minhnhat Ho

2. LITERATURE REVIEW 1971 – Homa, Kenneth and Jaffee, Dwight 1971 – Homa, Kenneth and Jaffee, Dwight –“The Supply of Money and Common Stock Prices” Evaluate usefulness of relationship as forecasting tool Evaluate usefulness of relationship as forecasting tool Stock price determined by growth rate of dividends (positively related to money supply), riskless interest rate and risk premium (negatively related) Stock price determined by growth rate of dividends (positively related to money supply), riskless interest rate and risk premium (negatively related) –Overall, average level of stock prices is positively related Used S&P500 along with money supply and growth in forecast model; found significant relationship Used S&P500 along with money supply and growth in forecast model; found significant relationship

3. 1972 – Hamburger and Kochin 1972 – Hamburger and Kochin –“Money and Stock Prices” 1974 – Rozeff 1974 – Rozeff –“Money and Stock Prices” Both papers found link between money supply and stock price level, also inferred monetary changes lead stock prices Both papers found link between money supply and stock price level, also inferred monetary changes lead stock prices 1974 – Cooper 1974 – Cooper –“Efficient Capital Markets and the Quantity Theory of Money” – Stock returns lead money supply changes, not lag as previously thought Stock returns lead money supply changes, not lag as previously thought

4. 1977 – Rogalski and Vinso 1977 – Rogalski and Vinso –“Stock Returns, Money Supply and the Direction of Causality” Found problems in previous papers Found problems in previous papers –Money supply data –Stock price series –Information lag Reinvestigate relationship between money supply and stock prices and establish their dependence Reinvestigate relationship between money supply and stock prices and establish their dependence Find direction of causality Find direction of causality

5. Conclusions: Conclusions: –Rate of growth of money supply is incorporated in returns –Stock market efficiency theory holds with respect to monetary information –Causality goes from stock prices to money supply Propose bidirectional theory of causality (confirmed in 1988 by Hashemzadeh and Taylor) Propose bidirectional theory of causality (confirmed in 1988 by Hashemzadeh and Taylor) –Change in monetary supply has direct impact on returns from common stocks

6. 1977 – Kraft, J. and Kraft, A 1977 – Kraft, J. and Kraft, A –“Determinants of Common Stock Prices: A time Series Analysis” Test causal relationship between stock prices and money supply, rate of change of money supply, corporate interest rate, measure of risk Test causal relationship between stock prices and money supply, rate of change of money supply, corporate interest rate, measure of risk Conclusions: Conclusions: –No causal relationship between money supply, change in money supply, Moody’s AAA corporate bond rate and common stock prices Further evidence for market efficiency hypothesis (past and current movements in money supply does not influence stock prices) Further evidence for market efficiency hypothesis (past and current movements in money supply does not influence stock prices)

7. 1982 – Sorensen, Eric 1982 – Sorensen, Eric –“Rational Expectations and the Impact of Money upon Stock Prices” Hypothesized unanticipated change in monetary aggregates have a more dramatic effect on the stock market than the anticipated changes Hypothesized unanticipated change in monetary aggregates have a more dramatic effect on the stock market than the anticipated changes Results: Results: –Market does not react abnormally to a large percentage of monetary activity either anticipated or unanticipated –Current and future changes in monetary aggregates causes large abnormal stock price returns

8. 2001 – Muradoglu and Metin 2001 – Muradoglu and Metin –“Is there a long run relationship between stock returns and monetary variables: evidence from an emerging market” Studied the Turkish stock market, Istanbul Securities Exchange since it’s inception in 1986 Studied the Turkish stock market, Istanbul Securities Exchange since it’s inception in 1986 Included exchange rate of several developed countries as independent variable Included exchange rate of several developed countries as independent variable Conclusions: more mature markets are less influenced by monetary expansion and interest rate Conclusions: more mature markets are less influenced by monetary expansion and interest rate

9. PLAN Investigate the relationship between common stock market price and money supply using the following time series: Investigate the relationship between common stock market price and money supply using the following time series:

10. RESULTS Coefficientt-statp-value M1(t)-16.06-0.260.792 Bond114.387.700 Sec-180.39-9.860 M1(t-1)-63.40-1.010.311 M1(t-2)-1.76-0.030.977 M1(t-3)15.470.450.654 M1(t+1)69.341.240.215 M1(t+2)-27.91-0.590.553 M1(t+3)28.591.240.217 Constant51.171.830.067

11. CONCLUSIONS Money aggregate is not a significant variable in determining the price of common stocks Money aggregate is not a significant variable in determining the price of common stocks The corporate bond rate is positively significant, while long term government securities rate is negatively significant The corporate bond rate is positively significant, while long term government securities rate is negatively significant There is no lead or lag effect from the monetary supply There is no lead or lag effect from the monetary supply