Investigating the Effects of Monetary Policy Shocks on Stock Price Bubbles: The Application of Structural Vector Autoregression with Time-Varying Parameters (SVAR-TVP)

In developing countries, the shocks that enter the economy due to capital market fluctuations have more depth and durability. Because of the two-way connection between the stock market and the real sector of the economy and public attention to this market, examining the stock market shocks is of great importance. Therefore, the present study investigated the extreme fluctuations of the stock market index, which suspected the existence of bubbles. Timing of these bubbles in the market is one of the goals of this study, which was carried out by using the right-tailed unit root tests based on the augmented Dickey-Fuller test. A stock price bubble may be affected by monetary policy. This issue is influenced by the size of the bubble and the type and strength of the applied monetary policy. The impact of monetary policy fluctuations and especially interest rates on stock price bubbles is theoretically uncertain and should be determined empirically. Therefore, another goal of this study is to examine the effects of monetary policy shocks on the formation and timing of the stock market bubble.

The method of Phillips et al.  (2015) has been used to identify and time the stock market bubble. Galli and Gambeti model and TVP-SVAR method were also used to investigate the effect of monetary policy on the stock market bubble.

BSADF (Backward Supreme Augmented Dicky-Fuller) test has been used to determine the dates when the stock market had a bubble. According to this test, in three short periods, from July to September 2005, from April to May 2011, and from October to November 2018, the stock market behaved like a bubble. Regarding the impact of the interest rate shock on the stock market bubble, it can be said that the monetary expansion shock (decrease in the real interest rate) causes the bubble part of the stock price to become larger. In all periods, the response of the bubble part was positive, but over time, has increased, and since the beginning of the 2010s, its response to the shock of interest rate reduction has completely changed. The liquidity shock, also strengthens the size of the bubble. The amount of this influence has also increased greatly over time and has reached its peak in 2017 (the year of the formation of the price bubble in the stock market based on the BSADF test). Therefore, it can be claimed that the increase in the bubble part of the stock price was caused by a positive shock or an increase in liquidity. Regarding the effect of the credit shock on the stock market bubble, it can be said that credits has affected the fundamental part of the stock price, but it does not have much effect on the bubble part of the stock price. In fact, the increase in credits has caused the liquidity restrictions of economic enterprises to be removed and has an effect on their production and sales and finally on their profitability. Therefore, it is expected that with an increase in credits (positive credit shock), most of the fundamental part (current and future profitability) of companies will be affected.

During the last decade, the public attention to the stock market in Iran increased significantly. This issue caused the entry of new funds into this market, which was seen in the bubble-like behavior of the stock price index. In the conventional economic theory, the positive impact of expansionary monetary policies on the bubble is expected, but there are other theories that make the long-term impact of the monetary policy shock on the size of the bubble uncertain and dependent on factors such as the size of the bubble, the stability of the monetary policy, and the type of monetary tool. In order to solve this theoretical ambiguity, the effect of one of these cases, i.e., changing the monetary policy tool, on the stock price bubble was investigated. Before that, the existence of a bubble in the stock market had been checked. Regarding the impact of monetary shocks on the stock price bubble, according to the type of monetary policy instrument, the reaction of the stock price bubble has been different. Interest rate policy and liquidity have had a positive effect on the bubble, but credit policy has not had such an effect. In most of the developed economies, the interest rate change is the most powerful monetary policy tool, as a small change in it can have a large impact on the real sector of these economies. But in our country, according to the empirical findings of this article, the effect of liquidity on the stock market bubbles has been greater than the effect of changing the interest rates on it. This result is a proof of the dominance of liquidity over monetary policies in Iran.