Summary of PHD thesis: The impact of monetary policy on the stock market

Research objectives: The impact of monetary policy on Vietnam stock market with regard to two aspects which are stock price and market liquidity.

BANKING UNIVERSITY HO CHI MINH CITY

DANG THI QUYNH ANH

THE IMPACT OF MONETARY POLICY ON VIETNAMESE

STOCK MARKET

SUMMARY OF PHD THESIS

MAJOR: FINANCE – BANKING

CODE: 62.34.02.01 SUPERVISORS:

ASS PROF DO LINH HIEP ASS PROF HA THI THIEU DAO

Hochiminh City, 2018

Summary

The stock market is a channel for mobilizing medium to long-term capital for the economy and is an investment channel which attracts the attention of the authorities, domestic and foreign investors Vietnam’s stock market has experienced over 16 years

of establishment and development There were periods when the stock market grew too fast (especially in the period of 2006 - 2007), only totake the plunge in 2008-2009, which affected investors, securities companies and financial services providers The volatility of the stock market is subject to many factors among which are the macroeconomic factors, especially the central bank's monetary policy which plays an important role

This dissertation was conducted to study the impact of monetary policy on the stock market during the period 2002 – 2016 using monthly time data collected from reliable sources Specifically: (i) study the impact of monetary policy (money supply, interbank interest rate) on the stock market in Vietnam (measured by VN-Index); (ii) study the impact of monetary policy (money supply, interbank interest rate) on Vietnam’s stock market liquidity (measured by 4 characteristics) The regression models used are the SVAR and VAR models based on the Eviews 8.0 software, and the research results show that:

(1) During the study period, the relaxing (tightening) of monetary policy by the SBV had the effect of increasing (decreasing) stock price immediately after 2 months and lasting up to 6 months later The variance decomposition shows that from January

2002 to December 2007, the impact of monetary policy on the stock market was not as strong as in the period from January 2008 to December 2016

(2) In addition, when SBV relaxes (tighten) the monetary policy by increasing (decreasing) the money supply, the liquidity of Vietnam stock market increases (decreases) The results of variance decomposition show that the money supply and interbank rates explain 8% - 10% of volatility of liquidity (or illiquidity) after a period

of 9-12 months The remaining variables explain 6% - 9% volatility of liquidity variables in shorter windows (only 3 months)

(3) Indicating the impact of monetary policy on stock prices: when SBV increases the total means of payment (or money supply), this reduces the mobilizing interest rate of commercial banks, making investment in securities more appealing and shooting up the demand for shares In addition, falling interest rates also reduces the cost of borrowing from businesses, thereby stimulating businesses to increase investment, expanding production and profit is expected to increase and so do stock prices

CHAPTER 1:INTRODUCTION 1.1 Research topic

Nowadays, most individuals are directly or indirectly involved in the stock market In deciding which stocks to buy or sell, investors need to estimate the expected rate of returns as well as the risk in investing in each stock Meanwhile, companies that raise capital from the sale of shares to the public need to decide what price to sell at and how many stocks to sell Policymakers need to understand the mechanism of the impact of changes in monetary policy management to the stock market, thereby accommodating the objective of stabilizing the stock market with their existing objectives Research by Bernanke and Gertler (2000) suggests that policymakers should maintain the stability of commodity prices in the economy to avoid impacting stock prices significantly

In order to find out which major factors have impact on the Vietnam’s stock market, there are a number of research topics carried out in different periods with different approaches The studies of Nguyen Son (2003), Dang Van Hai (2007), Hoang Xuan Que (2007), Tran Trong Triet (2008), Nguyen Thi Mui (2009), Le Hoang Nga (2009), Tran Hoang Ngan, 2009), VAFI (2012), Doan Ngoc Hoan (2013) have shown that short-term macro factors have certain impacts on the stock market In addition, longer-term quantitative studies also show that macro variables such as inflation, exchange rates, money supply, interest rates and industrial output have important impacton stock prices, rate of return or liquidity of markets (Tran Thi Xuan Anh and Ngo Thi Hang (2012), Phan Dinh Nguyen and Ha Minh Phuoc (2012), Phan Thi Bich Nguyet and Pham Duong Phuong Thao (2013), Nguyen Huu Huy Nhat (2013), Than Thi Thu Thuy and Vo Thi Thuy Duong (2014), Tran Thi Hai Ly (2015), Le Dat Chi (2015) )

At present, the Vietnam’s stock market has developed vigorously with remarkable growth and is considered one of the top five markets in the world as stock prices have returned to the peak achieved in 2007 However, there is no research on whether such development is stable and affected by macroeconomic factors, especially from the management of monetary policy of the State Bank of Vietnam has impact on the

market development The thesis entitled "The Impact of Monetary Policy on the

Stock Market" was conducted to clarify this issue, helping policymakers and investors

to unfold the impact of monetary policy on the price and liquidity of the stock market, thus devising appropriate operational policies and investment strategies

1.2 Overview of the literature (domestic and international studies)

Research on the impact of monetary policy on the stock market has been carried out since the 1970s (Rozeff, 1974; Pesando, 1974; Auerbach, 1976) The studies on the impact of monetary policy on the stock market across countries in the world have been conducted with different approaches

The first approach is to study the impact of monetary policy on the stock market, which considers the role of the stock market as a channel to convey the influence of the monetary policy on the economy Mishkin (2001), Cosimano et al (1999), Ehrmann and Fratzscher (2004), Berument and Kutan (2007) are typical studies of this type

The second approach is to study the reaction of stock prices to the announcement of the change in operating interest rates or money supply Under this approach, researchers often use event study methodology with high frequency (day or week) data to gauge the immediate impact of monetary policy announcementson the stock market price

A third approach is to use a regression model using monthly or quarterly data to assess the short- and long-term effects of monetary policy – related variables on stock prices (or returns ) and liquidity of the stock market The results of previous studies in the 1990s (Pesando, 1974; Rozeff, 1974; Rogalski and Vinso, 1977; Darrat, 1990) show that changes in monetary policy (money supply or interest rates) do not Granger cause the changes in share price (or return) This approach is also widely adopted in the context of emerging markets such as Tang et al (2013) in China, Abaenewe and Ndugbu (2012) in Nigeria, Seong (2013) in Singapore, Yoshino et al (2014) in South East Asian countries Most of the findings show that the shocks to monetary policy affect the stock price or the rate of return in the stock market: The tightening effect of monetary policy on stock prices is negative and vice versa

Domestic studies have been conducted mainly using the third approach, such as Nguyen Huu Tuan (2011), Phan Dinh Nguyen and Tang Trang Chau (2013), Nguyen Minh Kieu and Nguyen Van Diep (2013), Phan Thi Bich Nguyet and Pham Duong

Phuong (2013), Bui Kim Yen and Nguyen Thai Son (2014), Duong Ngoc Mai Phuong and Vu Thi Phuong Anh (2015), Than Thi Thu Thuy (2015) However, in general these studies only assess the impact of macro factors on the stock market without examining the impact of monetary policy on stock prices and liquidity of the market

1.3 Objectives and research questions

+ Clarify the mechanism of impact of monetary policy to share price and liquidity

of Vietnam’s stock market

+ Make recommendations for policymakers to support the development of the stock market and for investors to increase profits, reduce risks

b Research questions

+ Does the monetary policy affect stock prices in Vietnam stock market? If so, what

is the direction and magnitude of the impact of monetary policy factors on the stock market in Vietnam?

+ Does the monetary policy affect the liquidity of the Vietnamese stock market? If

so, how are the trends and magnitude of the impact of monetary policy factors on market liquidity?

+ What is the impact of monetary policy on stock prices and liquidity of the stock market?

+ What are the recommendations for policymakers to support the development of the stock market?

1.4 Object and scope of the study

Research objectives: The impact of monetary policy on Vietnam stock market with

regard to two aspects which are stock price and market liquidity

Research scope:

+ Space: The stock market referred is the trading exchange of HOSE (HSX)

+ Time: study the impact of monetary policy on the Vietnam’s stock market from January 2002 to December 2016, with information collected from reliable sources such as SSC, HOSE, Hanoi Stock Exchange, SBV, IFS, ARIC and some websites such

as Cafef, Stox Plus

To address question 2, the thesis utilizes a vector autoregressive model (VAR) based

on the research model of Chordia and ctg (2005), Lu-Andrews and Glascock (2010), Fernández-Amador and ctg (2013)

Basing on the results of these two models and combining with the qualitative method, the dissertation strives to analyze the implementation of monetary policy by SBV in reality, the evolution of the development of the Vietnam’s stock market, thus indicating the mechanism of impact of monetary policy on the stock market and providing some policy recommendations to the authorities and investors

1.6 The scientific and practical contributions of the thesis

a Scientific contribution

In the Vietnam’s stock market, although there are many studies on the impact of macro variables on the stock market, there have been no studies on the single impact of monetary policy on stock prices and market liquidity This study was conducted over a long period of time, including the period of strong growth, recession and recovery In addition, the study also shows the impact of monetary policy on the development of

the Vietnamese stock market, in terms of the extent and direction of those effects The results of the study are based on empirical verification through the SVAR and VAR models, ensuring reliability so that they can be used for future research not only in updating theories but also comparing results of extant studies

b Practical contribution

Research shows that the increase (decrease) of money supply has the effect of increasing (decreasing) stock prices as well as liquidity of the stock market This helps the policymaker see the mechanism of impact of monetary policy to the stock market, thus developing policies suitable to the conditions of the economy as well as supporting the development of the stock market Investors can use research results as a reference for making investment decisions in accordance with each stage of the economy as well as the monetary policy administration of SBV

1.7 New findings from research results

In the periods of expansion (tightening), the monetary policy has the effect of increasing (decreasing) stock prices in the stock market immediately after 2 months and lasting up to 6 months thereafter VNI reacted in the same direction to the increase

in money supply and in the opposite direction to the rise of interbank rates VNI's reaction to the change in money supply is stronger than that in interbank rates The variance decomposition shows that from January 2002 to December 2007, the impact

of monetary policy on the stock market was not as strong as in the period from January

2008 to December 2016

VNI has reacted quite strongly to the shock in consumer price index, particularly VNI started falling from the first month of the CPI shock and reached a new equilibrium level of 6% fall after 3 periods

In addition, the SBV’s loosening (tightening) monetary policy by increasing (decreasing) money supply tends to increase (decrease) the liquidity of the stock market The results of variance decomposition show that the money supply and interbank rates explain 8% - 10% volatility of liquidity (or liquidity) after a period of 9-12 months The remaining variables explain 6% - 9% of the volatility of liquidity variables in shorter windows (only 3 months)

The research has shown the mechanism of impact of monetary policy to share price and liquidity of Vietnam stock market In particular, the increase in money supply by the SBV has reduced the market interest rates and reduced the cost of debt to businesses, thereby increasing profitability for listed companies At the same time, the reduction in interest rates also increases the demand for shares from investors, thus increasing the stock price and increasing the value of stocks traded on the stock market

1.8 Structureof the dissertation

The dissertation comprises of 5 chapters as follows:

Chapter 1: Overview of research topic

Chapter 2: Theories on the impact of monetary policy on the Stock Market

Chapter 3: Modeling and Research Methods

Chapter 4: Research Results and Discussion

Chapter 5: Conclusions and policy recommendations

CHAPTER 2 THEORIES ON THE IMPACT OF MONEY POLICY ON THE

2.1.2 Securities market

The stock market is the place where exchanging, trading and transfering of medium to long-term securities are held, thereby changing the owners of securities Basically stock market is the operating process of capital This is the place to buy and sell the property rights related to capital and is a form of advanced development of goods production

A stock price index is an indicator that reflects the change of stock prices at a time compared to the original price Stock price indexes are the most important information

in the market and are often used by investors in stock investment analysis (Nguyen Dang Nam, 2006)

2.2 Impact of monetary policy on the stock market

2.2.1 Impact of monetary policy on stock prices

According to Brunner's monetary theory of monetary volume (1961), Friedman and Schwartz (1975) monetary policy can influence stock prices by choosing the investment portfolios:

MS ↑ → due to the effect of wealth effect → stock demand ↑ → stock price ↑

Basing on Gordon's dividend discount model (1962), Patelis (1997) suggested that MP could influence stock prices in two ways The first way is to directly influence the stock price by affecting the interest rate expected by investors The second way is to indirectly influence the stock price by affecting the expected return of the company in the future, thereby affecting the expected dividend

MS ↑ → r ↓ → SP ↑ (direct impact)

MS ↑ → r ↓ → Y ↑, CF ↑ → SP ↑ (indirect effect)

According to the efficient market theory (Fama (1970)):in a medium-efficient market shows that changes in the expectation of money supply are included in the published information, thus having no value in stock price forecasts

MS ↑ out of expectation → inflation ↑ expected → r ↑ → Y ↓, CF ↓ → SP ↓

MS ↑ out of expectation → future tightening monetary policy expected → r ↑ → Y ↓,

CF ↓ → SP ↓

MS ↑ out of expectation → policy uncertainty ↑ → risk increase → SP ↓

2.2.2 Impact of monetary policy on stock market liquidity

Concept of stock market liquidity: The stock market is considered to have good liquidity if the following conditions are met: (i) there is always an ask price and offer price so that investors can trade immediately; (ii) the difference between the ask price and the bid price is marginal; (iii) investors can buy large amounts of securities immediately with low transaction costs According to Baker (1996), market liquidity features include: instantness, breadth, depth and elasticity

Impact of monetary policy on stock market liquidity: According to O'hara's (1995) micro-market structure theory, the liquidity of each stock depends on the characteristics of the stock and the trading mechanism in the market Monetary policy can influence the liquidity of stocks in the market througheasing (or tightening) monetary policy whichwill reduce (or aggravate) margin borrowing, thereby increasing (decreasing) capital liquidity of market participants

2.3 Related studies

2.3.1 Overseas studies

Research on the impact of monetary policy on the stock market has been carried out since the 1970s (Rozeff, 1974; Pesando, 1974, Auerbach, 1976) in which the impact

of money supply stock prices on the US stock market Then, studies on the impact of monetary policy on the stock market in countries around the world continue to develop different approaches

The first approach is to study the impact of monetary policy on the stock market, which considers the role of the stock market as a channel to convey the impact of the monetary policy to the economy In addition to traditional transmission channels such

as credit interest rates, asset price channels are also increasingly important

The second approach is to study the reaction of stock prices in the market to the announcement of the change in operational interest rates or money supply Under this approach, researchers often use event window methodology and high frequency (day

or week) data to measure the immediate impact of monetary policy announcements (policy announcements effect) on the stock market price

Third approach: Using the regression model with monthly or quarterly data to assess the short- and long-term effects of monetary policy variables on stock price (or historical return) in the stock market The results of studies prior to the 1990s (Pesando, 1974; Rozeff, 1974; Rogalski and Vinso, 1977; Darrat, 1990) show that changes in monetary policy (money supply or interest rates) do not Granger cause stock price (or stock return) This type of methodology is also widely adopted in the emerging markets such as Tang et al (2013) in China, Abaenewe and Ndugbu (2012)

in Nigeria, Seong (2013) in Singapore, Yoshino et al (2014) in South East Asian countries Most of the research results show that the shocks in monetary policy affect the stock price or the rate of return in the stock market: tightening monetary policy has negative impact on stock price or stock returns and vice versa However, the level of impact depends on the specific conditions of each country, the study period and the variables studied

In recent years, especially after the 2008 financial crisis, the issue of stock market liquidity was particularly considered Stock markets with good liquidity will create favorable conditions for capital flows between investors, savers and lenders, and benefiting the economy as a whole The effectiveness of monetary policy also depends

on the liquidity of the financial market, including the stock market The results of the study by Fernández-Amador et al (2013) also show that the expansion of the central bank's monetary policy leads to an increase in liquidity in the stock markets in Germany, Italy and France Therefore, a new research direction when assessing the impact of monetary policy on the stock market is to study the impact of monetary policy variables on the stock market liquidity

2.3.2 Domestic studies

Research on the impact of macro factors on stock prices in Vietnam stock market mainly adopts two approaches The first approach is to use the qualitative method to analyze, to describe the actual situation of the stock market and its influences, such as the studies by Nguyen Son (2003), Dang Van Hai (2009), VAFI (2012), Doan Ngoc Hoan (2013)

The second approach is a longer-term quantitative study to assess the impact of a number of macro variables such as inflation, exchange rates, money supply, interest rates, industrial output on stock prices, stock returns and liquidity ratios such as Tran Thi Xuan Anh and Ngo Thi Hang (2012), Phan Dinh Nguyen and Ha Minh Phuoc (2012), Phan Thi Bich Nguyet and Pham Duong Phuong Thao (2013), Nguyen Huu Huy Nhut (2013), Than Thi Thu Thuy and Vo Thi Thuy Duong (2014), Tran Thi Hai

Ly (2015), Le Dat Chi (2015)

2.4 Gaps in the field of research

+ There has not been much in-depth study on the impact of monetary policy on the stock market in Vietnam for a long time from 2002 to 2016

+ There has been no study on the impact of monetary policy on the liquidity of Vietnam’s stock market and the liquidity is measured by four liquidity characteristics: instantness, breadth, depth and elasticity of the market

Summary of Chapter 2

Chapter 2 presents an overview of theoretical background and studies related to the impact of monetary policy on the stock market

CHAPTER 3: RESEARCH METHODOLOGY 3.1 Research model

3.1.1 Study the impact of monetary policy on stock prices in Vietnam’s stock market

According to Lütkepohl (2005), the general form of the SVAR model with exogenous variables as follows:

To achieve the first research objective and based on Kim's research (1999), Kim and Roubini (2000), Ben Naceur et al (2007) structural shocks with vector variablesYt is formatted as follows:

In models (3.2) and (3.3), two exogenous variables, namely the federal interest rate for the United States and the world oil price, represent the external shock In particular, the FFR represents the FED's monetary policy, which affects the domestic output (IPI), the monetary policy of the SBV and the stock price in the Vietnam According to

Li et al (2010), world oil prices (OIL) have a simultaneous effect on macro variables such as output, inflation and stock prices The third equation represents the relationship between real economic activity and inflation and the monetary policy variables The fourth equation represents the simultaneous response of CPI to output

The fifth equation represents equilibrium in the monetary market According to the monetary theory of Friedman and Schwartz (1975) the demanded amount of money depends on the income and opportunity costs of holding money Therefore, total money supply depends on output, price and interest rate in the economy The sixth equation illustrates the shock of monetary policy in which interest rates do not react simultaneously to stock prices, inflation and output but react only after a lag The last equation shows the relationship between the stock price and the variables in the model, where the stock price reacts instantaneously to the shocks of the monetary policy, the price, the output and the external shocks

3.1.2 Research into the impact of monetary policy on Vietnam’s stock market liquidity

To achieve the second research objective, the thesis uses the research model of Chordia et al (2005) as the theoretical basis for the relationship between variables in the VAR model This is also the model used in many studies in the world such as Lu-Andrews and Glascock (2010), Fernández-Amador et al (2013)

, , , , , ,

In model 3.4, zt is a vector of endogenous variables, including variables representing the stock market liquidity, the variable representing the monetary policy, the variable representing economic activity which is the index of industrial production and inflation; ut is the vector of the residuals, c is the constant vector, and A is the square matrix of nxn, which includes the regression coefficient of all endogenous variables in the model

The LIQt variable is the variable that represents the five variables of the stock market liquidity: Zeros, LR, MLI, Turnover and Ailliq Group variables for monetary policy

are money supply (M2) and interbank interest rate (IR) Control variables include the monthly average return on equity (SR), inflation (CPI) and industrial output (IPI)

The order of variables in the model is based on previous studies by Chordia et al (2005), Goyenko and Ukhov (2009), Fernández-Amador et al (2013) Accordingly, macro variables such as output (IPIt), inflation (CPIt) are sorted first, followed by monetary policy variables such as money supply (M2t), interbank rates (IRt), the rate

of return on equity (SRt), liquidity variables (LIQt)

3.2 Research hypothesis

The equation for the effect of variables on stock prices on the stock market is written from the structural matrix (3.2) as follows:

VNIt = Φ70 + Φ71.FFRt + Φ72.OILt +Φ73.IPIt + Φ74.CPIt + Φ75.M2t +Φ76.IRt + εt (3.5)

VNI is expected to fluctuate along with output growth, money supply growth (Φ73 and Φ75 respectively) On the contrary, VNI is expected to move in reverse with the increase in consumer prices and the increase of interbank interest rates (respectively Φ74 and Φ76 bear negative sign)

Expectations on the impact of monetary policy on the liquidity of the stock market are shown in Table 3.1 below:

Table 3.1 Expectations of the impact of monetary policy on liquidity of the stock market

Liquidity measures

Expected sign Monetary supply growth

Table 3.2 summarizes the calculation of research variables and data sources

Zeros transaction days with zero return within a month

Number of total transaction days

HOSE, StoxPlus, Cafef

TV Total value of stocks traded within a month

LR Liquidity ratioLR ∑∑ | |Turnover Stock turnover ratio:Turnover x 100%

MLI Liquidity index Martin MLIt= ∑ Pt -Pt-1 2

CHAPTER 4: RESULTS AND DISCUSSIONS 4.1 Evolution of monetary policy and development of the Vietnam’s stock market

in the period of 2002 - 2016

4.1.1 Management of monetary policy in the State Bank of Vietnam

+ On defining the ultimate goal

Judged from the implementation of monetary policy in the period from 2002 to 2010, the SBV has implemented multi-objective monetary policy including spurring economic growth, curbing inflation and stabilizing the exchange rate From Table 4.1, annual GDP growth rate and CPI growth rate in the resolution on socio-economic development plan are determined by the National Assembly Accordingly, the government and the SBV must strive to achieve the set goals In the period before

2007 (before Vietnam's accession to the WTO), the objectives and results of implementation matched rather well However, after 2007, especially in the period

2008 - 2011, output growth often did not reach the target, while inflation was always higher than targeted

Table 4.1 Final objective of Vietnam monetary policy for the period 2002-2016

Note: * denotes change during a year

Source: Compiled from the National Assembly's Resolution on Socio-Economic Development Plan and GSO's Socio-Economic Development Report from 2002 to

2016

The Law on State Bank of Vietnam (SBV), which came into force on January 1, 2011, marked a major change in the viewpoint of monetary policy by defining the highest objective which is stabilizing the currency (measured by inflation target set by the National Assembly (Article 3 of the Law on State Bank of Vietnam 2010) The result of this change is clearly manifested by the inflation rate after 2011 In 2014, inflation was only 1.84%, much lower than the target of 7% set by the National Assembly Tightening credit, reducing consumer demand and falling world oil prices have led to this

+ Determining intermediary and operational goals

On the basis of the ultimate goal, the intermediary target system and operational objectives are also gradually established In fact, due to monetary policy in Vietnam targeting many objectives, the intermediary objectives are usually diversified, depending on the currency evolution of each period

From the very beginning of its operations, SBV governed its monetary policy principally by regulating the amount of annual monetary supply and this fact continues

to exist during the study period It is therefore true that the SBV has chosen the intermediary target based on the volume of money supply Since 1995, the State Bank

of Vietnam (SBV) has been regulating the SBV's annual money supply to stabilize the currency according to the planned targets This additional amount of money supply is determined on the basis of the growth rate of total payment instruments (M2 money supply), in line with the GDP growth rate and the expected inflation rate and the money-generating coefficient plans of credit institutions After the Prime Minister has approved the annual increase in money supply, the governor of the SBV administers the provision of money within the limits of government approval through the administration of monetary policy instruments, which has impact on money supply to achieve intermediary objectives (Table 4.2)

Table 4.1 The intermediary objective of Vietnam monetary policy for the period

2002 – 2016

Năm Money supply growth M2 (%) Credit growth (%)