Stock Market Liquidity and Monetary Policy

Abstract

Purpose: This article investigates the deterministic relationship between monetary policy and stock market liquidity in South Africa. Design/Methodology/Approach: The Ordinary Least Square Method was used to capture the nexus between the Johannesburg Stock Exchange indices and selected liquidity measures over the period of 2002 to 2019. The liquidity measures chosen were multi-dimensional in nature, exhibiting characteristics such as tightness, immediacy, depth, breadth and resiliency. Findings: Empirical evidence shows that liquidity depend on monetary policy adjustments as the results reveal that liquidity is dependent on changes in South African Benchmark overnight rate (SABOR). The strength and significance of the relationship depended on the indices and period of analysis. The liquidity measure used was also influential as the results showed a negative relationship between SABOR and adjusted illiquidity measure in line with theory. Also, in line with theory effective spread was found to be positively related with SABOR. The relationship conflicted the theory on the trading volume as it was positively related to SABOR. However, the analysis could not confirm that the relationship between liquidity and monetary policy is asymmetric. Practical Implications: The article highlights the fact that stock market investment professionals, traders and regulators should account for the effects of changes in interest rates when modeling market frictions like liquidity. Originality/Value: An investigation was done in an emerging equity market which is different from the dynamics and mechanics of the developed equity markets because the emerging stock markets are illiquid and constitute a lot of market imperfections. Furthermore, developing countries’ financial markets are extremely segmented and less efficient. The results revealed important insights that stock liquidity is time variant and index dependent and contrary to many studies the relationship between stock liquidity and monetary policy is not asymmetry.