Causal Relationship between Monetary Policy and the Stock Market: a Bootstrap Rolling Window Approach

Abstract

This study examines the causal relationship between the monetary policy and the stock price in Pakistan. We use bootstrap Granger full-sample causality test and sub-sample rolling window estimation test for the period of 1992:01 to 2015:06. The empirical result shows that there is a unidirectional causality from monetary policy to the stock price. However, considering the structural changes, we assess the parameter stability by using the full sample for short run relationship and find the short run instability for the full sample. This recommends that full-sample data cannot depend upon for the precise result. To address the structural changes issue, we propose rolling window approach is used to revisit the causal relationship between the two series and the result reports the bi-directional causal relationship between the monetary policy and the stock market. The relationship between the stock market and the money supply is not consistent, and the upward trend may cause serious policy implication on the stock market for future investment and profit.