Impact of Monetary Policy on Financial Markets Efficiency and Speculative Bubbles: A Non-linear Entropy-based Approach

Alonso-Rivera, Angélica and Cruz-Aké, Salvador and Venegas-Martínez, Francisco (2014): Impact of Monetary Policy on Financial Markets Efficiency and Speculative Bubbles: A Non-linear Entropy-based Approach.

Abstract

This paper examines, through the concept of mutual information based on entropy, the impact of monetary policy on the loss of efficiency in the financial markets and speculative bubbles. The proposed information measure is useful to quantify the efficiency with which financial markets respond to the implementation of monetary policy. The findings show that an increase in both money supply and credit growth, as well as a declining of interest rates, generate strong inefficiencies during the initial periods of formation of a bubble. Moreover, empirical evidence suggests that when a loose monetary policy generates inefficiencies, its instruments are not effective to realign the performance of financial markets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy, speculative bubbles, market efficiency, non-linear models, entropy.
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies

References

Alvarez-Ramirez, J., E. Rodriguez y J. Alvarez (2012). A Multiscale Entropy Approach for Market Efficiency. International Review of Financial Analysis, Vol. 21, pp. 64-69.

Adam, M. C. and A. Szafar (1992). Speculative Bubbles and Financial Markets. Oxford Economic Papers, Vol. 44, No. 4, pp. 626-640.

Borio, C. and P. Lowe (2002). Asset prices, financial and monetary stability: exploring the nexus. BIS, working papers no. 114, July.

Bordo, M. D. and J. Landon-Lane (2013). Does expansionary monetary policy cause asset price booms; some historical and empirical evidence. National bureau of economic research October 2013 Working Paper 19585 http://www.nber.org/papers/w19585.

Campbell, J. Y. and T. Vuolteenaho (2004). Inflation Illusion and Stock Prices, The American Economic Review, Vol. 94, No. 2, pp. 19-23.

Christiano, L., C. L. Ilut, R. Motto, M. Rostagno (2010). Monetary policy and stock market booms. National bureau of economic research, Working Paper 16402. September 2010. http://www.nber.org/papers/w16402.

Cruz-Aké, S., R. S. García Ruiz y F. Venegas-Martínez (2014). Una medición no lineal de la dependencia de la inflación sobre el tipo de cambio nominal (pass-through). El Trimestre Económico, forthcoming.

Delgado-Selley O. (2011). La hipótesis de la inestabilidad financiera y la crisis de 2007-2009. Economía Teoría y Práctica, Vol. 34. No.1, 9-41.

Dow, C. Sheila (2007). Endogenous Money: Structuralist. “A HandBook of Alternative Monetary Economics”. C3. Edward Elgar Publiching.

Detken, C. and F. Smets (2004). Asset price booms and monetary policy. European Central Bank, Working paper series no.364 may (2004). http://www.ecb.int or from the Social Science Research Network electronic library at http://ssrn.com/abstract_id=533122

Fama, E. F. (1965). Random walks in stock market prices. Financial Analysts Journal, pp. 55–59. Reprinted in 1995 as Random Walks in Stock Market Prices, Financial Analysts Journal, Vol. 51, No. 1, pp. 75–80.

Fama, E. F. (1970), Efficient capital markets: A review of theory and empirical work, The Journal of Finance, Vol. 25, No. 2, pp. 383–417.

Galí, J. (2013). Monetary policy and rational asset price bubbles. National bureau of economic research, working paper 18806, february 2013. http://www.nber.org/papers/w18806

García-Kobeh, A., J. P. Graf-Noriega, G. Hernández-Chávez y R. Paniagua-Ruiz (1990). Economía monetaria de producción y circuito. Economía Teoría y Práctica, No 1. No. 1, pp. 149-170.

Gilchrist, S., and M. Saito (2006). Expectations, asset prices, and monetary policy: the role of learning. National bureau of economic research, Working Paper 12442 August 2006. http://www.nber.org/papers/w12442

Gordon, M. (1982). The investment, financing, and valuation of the corporation. Greenwood Publishing Group, Inc.

Greenspan, A. (2004). Innovations and Issues in Monetary Policy: The Last Fifteen Years Risk and Uncertainty In Monetary Policy. The American Economic Review vol. 94, No. 2, pp. 33-40.

Karatzas, I. and S. E. Shreve (1991). “Methods of Mathematical Finance”. Springer 1991.

Kindleberger, C. P. (2005). “Manias, panics and crashes. A History of Financial Crises”. (1978); 3ª ed.,Wiley. New Jersey (2005).

Minsky, H. P. (1992). The Financial instability hypothesis. The Jerome Levy Economics Institute, working paper no. 74. (May 1992). Available at SSRN: http://ssrn.com/abstract=161024

Mishkin, F. S. (2011). How Should Central Banks Respond to Asset-Price Bubbles? The 'Lean' versus 'Clean' Debate After the GFC Reserve Bank of Australia, Journal RBA Bulletin, June 2011.

Lavoie, M. (2007). “A Hand Book of Alternative Monetary Economics”. C2 Endogenous Money: Acommodationist. Edward Elgar Publishing.

Ludwig, K. K. (2006). Insider Trading rules and price formation in security markets. An entropy analisis of strategic trading. International Journal of Theoretical and Applied Finance, Vol. 9, No. 8, pp. 1215-1243.

Pincus, S. M. (1991). Approximate entropy as a measure of system complexity. Proceedings of the National Academy of Sciences.

Risso, W. A. (2008). The US Housing Bubble and the Informational Efficiency. Available at SSRN: http://ssrn.com/abstract=1259427

Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends? American Economic Review, vol. 71, pp. 421–436.

Trichet, J. C. (2005). Asset price bubbles and monetary policy. Speech by President of the ECB. 8 June 2005, Singapore.

Villegas, E., A. Acosta y R. Cayaffa (2010). La crisis hipotecaria estadounidense: origen y evolución. Cuadernos Latinoamericanos, Año 21. pp. 49-68

Wang Gang-Jin, Xie Chi, Han Feng (2012). Multi-Scale Approximate Entropy Analysis of Foreign Exchange Markets Efficiency. Systems Engineering Procedia vol. 3, 201-208.