Does Monetary Policy Determines Liquidity? New Evidence from Pakistan Stock Market

Abstract

Monetary policy and its influence on liquidity is one of the most contentious issues in recent periods. As Pakistan is an emerging market with growing opportunities so people’ interest is increasing and investors are more concern about liquidity position of Pakistan market. This research using sample of 100 firms listed at Pakistan Stock Exchange (non-financial) for the period 2000-2020. In first step, simple regression is estimated to investigate the effect of monetary policy on market liquidity. In which the liquidity of market in month t is modeled as a function of the Industrial growth rate (IGRt), Inflation rate (INFt), market return (RMt), standard deviation (SDt) and real interest rate (INTt). In second step, in-depth investigation is encountered that how announcement of new monetary policy determines the liquidity of individual stocks listed on PSX 100 index. For that purpose, panel regressions (fixed effect model) are estimated in which the liquidity (LIQi,t) of stock i in month t is modeled as a function of the (one-month lagged) SBP’s monetary policy, the interaction term and other lagged control variables. Findings can be summarized firstly, at stock market level, results confirm that expansionary monetary policy entails more liquid stock markets. Secondly, study complement the micro analysis and find that expansionary (restrictive) monetary policy results in an increase (decrease) in stock liquidity. This study is helpful for investors in devising investment plans on the basis of assessing certain facets of liquidity like risk, return, inflation rate, trading volume.