The Effect of Monetary Policy on Stock Price Bubble in Tehran Stock Exchange

Bubble is prolonged stock price boom, which is always followed by bust, in the sense that the initial increases in prices are due to the expected increase in the future that attracts new buyers and thus speculators. The main hypothesis of this research is whether the increasing stock prices are driven by market fundamentals or just by speculation. In this paper to investigate the relationship between monetary policy and stock prices, the transmission mechanism is based on linearized rational expectations model with assuming the forward-looking behavior of stock prices, have been considered in the framework of the New Keynesian Academy. Experimental analysis during 2000:M1 to 2010:M2 using GMM procedure, shows that real interest rates have negative effect, and expected output has a positive effect on real stock returns. Also, past stock returns have a positive momentum on current stock prices, which represents the speculation causing the deviation of prices from their intrinsic values.