Abstract
We use a cointegrated structural vector autoregressive model to investigate the relation between euro area monetary policy and the stock market. Since there may be an instantaneous causal relation we consider long-run identifying restrictions for the structural shocks and also use (conditional) heteroskedasticity in the residuals for identification purposes. Heteroskedasticity is modelled by a Markov-switching mechanism. We find a plausible identification scheme for stock market and monetary policy shocks which is consistent with the second order moment structure of the variables. The model indicates that contractionary monetary policy shocks lead to a long-lasting down-turn of real stock prices.
Highlights
The interaction of monetary policy and the stock market has been studied extensively with structural vector autoregressive (VAR) models
Bjørnland and Leitemo (2009) considered a structural VAR model for the US, where long-run and short-run restrictions were combined to identify structural shocks. Such models were used in the context of identification by heteroscedasticity (e.g., Lütkepohl and Netšunajev 2017a, 2017b; Bertsche and Braun 2018). All these studies investigated the relation between monetary policy and the stock market in the US, but they ignored that the variables may be cointegrated
We model the conditional heteroscedasticity in the data by a Markov-switching (MS) mechanism and find a cointegrated structural VAR model for which conventional identifying restrictions are in line with the second-moment structure of the data
Summary
The interaction of monetary policy and the stock market has been studied extensively with structural vector autoregressive (VAR) models. Bjørnland and Leitemo (2009) considered a structural VAR model for the US, where long-run and short-run restrictions were combined to identify structural shocks Such models were used in the context of identification by heteroscedasticity (e.g., Lütkepohl and Netšunajev 2017a, 2017b; Bertsche and Braun 2018). M identified the ECB monetary policy shocks using an event-study approach and via heteroscedasticity following Rigobon and Sack (2004) Both identification methods yielded a negative relationship between unexpected changes in policy rates and stock returns. Used different techniques to investigate the relation between ECB monetary policy and German stock returns, including an event study, a VAR analysis—where monetary policy surprises are captured by a proxy variable—and a threshold VAR model.
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