Abstract
We examined the potential relationships between changes in the money supplies of Korea and the United States and volatility of the Korean stock market using the GARCH, GJR-GARCH, and EGARCH models. We did not identify any such relationships, implying that changes in money supply do not influence the flow of information to the market. However, we found that the asymmetric effect of bad news on volatility was higher when contemporaneous changes in Korean and US money supply variables were included in the models. This indicates that changes in money supply did not affect Korean stock volatility directly. Finally, the results based on a variance model indicated that the money supply of the two countries had no effect on the Korean stock market. This formal study suggests that there is no significant forecasting power of past changes in money supply. Although stock returns and volatility are not directly affected by changes in the money supply, the influence of supply on macroeconomic activity should not be disregarded.
Highlights
Financial economists are very interested in whether money supplies affect stock returns, and various studies have established that they do [1]-[3]
If an increase in money supply invokes a decrease in real interest rates, investors would expect stock returns to become higher after an increase in the money supply
We examined the relationships between changes in money supply and stock volatility for the domestic economy of Korea
Summary
Financial economists are very interested in whether money supplies affect stock returns, and various studies have established that they do [1]-[3]. (2015) The Effect of Money Supply on the Volatility of Korean Stock Market. Few papers have analyzed the effects of supply changes on stock return volatility. Of those that have, most have analyzed relationships using a VAR model and the Granger causality test. We investigated whether changes in money supply, as a proxy for information flow, can be used to improve predictions of volatility. For this purpose, we examined the relationships between changes in money supply and stock volatility for the domestic economy of Korea.
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