Did Demonetization Affect Indian Stock Market? A Short-Term Analysis

Abstract

This paper analyzes the shocking episode of “2016 demonetization” in India. The policy declared 86% of cash in circulation in the form of INR 500 ($7.5) & INR 1000 ($15) notes as an illegal tender effective from midnight of November 8, 2016. However, the government of India gradually introduced new notes of INR 500 and INR 2000 ($30) over the next several months. This is considered as one of the biggest macroeconomic shocks that happened in a stable economic environment. Following the demonetization announcement, there was a rapid decline in the stock prices of cash-sensitive sectors like consumer goods and financial services, signaling a lower market expectation of a fall in demand. However, demonetization has affected purchasing power, which sharply declines the demand for various goods and services. Therefore, this paper focuses on the short-term impact of demonetization announcement on the stock price of 100 publicly listed firms in India using daily data. We use an estimation window that ranges from one week after the announcement to 60 days to capture the short-term announcement effect. Ordinary Least Square (OLS), Fixed Effect (FE), and Random Effect (RE) estimation techniques are used in this study. The results found that the announcement effect of demonetization sharply declines the stock prices of Indian firms. To control heterogeneous effect among the firms, this paper divides the firm into “Economic & Financial sectors” and “other sectors” and found that stock prices were severely affected by the demonetization announcement in the short-term.