The Effect of Money Supply on the Volatility of Korean Stock Market

Abstract

We examined the potential relationships between changes in the money supplies of Korea and the United States and volatility of the Korean stock market using the GARCH, GJR-GARCH, and EGARCH models. We did not identify any such relationships, implying that changes in money supply do not influence the flow of information to the market. However, we found that the asymmetric effect of bad news on volatility was higher when contemporaneous changes in Korean and US money supply variables were included in the models. This indicates that changes in money supply did not affect Korean stock volatility directly. Finally, the results based on a variance model indicated that the money supply of the two countries had no effect on the Korean stock market. This formal study suggests that there is no significant forecasting power of past changes in money supply. Although stock returns and volatility are not directly affected by changes in the money supply, the influence of supply on macroeconomic activity should not be disregarded.