Response of Stock Markets to Monetary Policy: The Tehran Stock Market Perspective

Abstract The article assesses the response of Tehran stock prices to exogenous monetary policy shocks, using a vector error correction model for the 1998Q1–2013Q2 period. Monetary policy is transmitted to stock market price through three routes: money by itself, exchange rate and inflation. Our result in this paper points to the fact that stock prices increase persistently in response to an exogenous easing monetary policy. Variance deposition results show that, after ten periods, the forecast error variance of more than 53 per cent of the Tehran Stock Exchange Price Index (TEPIX) can be explained by the exogenous shocks to the US dollar–Iranian rial exchange rate, while this ratio for exogenous shocks to the Iranian real gross domestic product was only 17 per cent. The article argues that such evidence can be accounted for by an endogenous response of the stock prices to the monetary policy shocks.