Contagion Effects of Monetary Policy on the JSE ALSI

Abstract

This study will investigate the effect of changes in monetary policy variables on the South African stock market. The component variable under study is the JSE ALSI and its responsiveness to movements in interest rates, money supply and the rand-dollar exchange rates. The Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Model provide a benchmark for setting stock prices. In this paper the aforementioned variables are tested and integrated in these models to determine how much of an effect they have on the stock index. The study will use Granger Causality tests, unit root tests and the standard Ordinary Least Squares (OLS) method to interrogate the hypotheses put forward relating the JSE ALSI and interest rates, money supply and exchange rates. The main argument put forward is that monetary policy does significantly impact stock index movements and hence it is imperative to monitor the relationship so as to control for adverse contagion effects during economic shocks.