Do Central Banks React to the Stock Market? The Case of the Bundesbank

29 Pages Posted: 8 Nov 2003

See all articles by Martin T. Bohl

Martin T. Bohl

University of Muenster

Pierre L. Siklos

Wilfrid Laurier University - School of Business & Economics; Balsillie school of international affairs

Thomas Werner

European Central Bank (ECB)

Abstract

In this paper, we investigate the relationship between stock returns and short-term interest rates. Identification of the stock return-interest rate relation is solved by using a new technique that relies on the heteroskedasticity of shocks to stock market returns. We suggest some improvements to the identification technique and its justification, as well as providing some new findings. In particular, we ask whether the Bundesbank, prior to the European Central Bank taking responsibility for monetary policy in 1999, reacted systematically to stock price movements. In contrast to the results for the US, our empirical findings for the 1985-1998 period show a positive, but statistically insignificant, parameter for the relationship between German stock returns and short-term interest rates at the daily frequency. The same result is found at the monthly frequency. Nevertheless, the confidence bands are wide enough that we cannot entirely exclude the possibility of a reaction at lower frequencies. The results are extremely robust to alternative methods used to identify changes in heteroskedasticity. The evidence is, therefore, inconsistent with the hypothesis of a systematic reaction of the Bundesbank to every wiggle in German stock prices. Both the historical and institutional evidence are supportive of this conclusion.

Keywords: Stock Prices, Monetary Policy, Reaction Function, Deutsche Bundesbank, Identification, Simultaneity

JEL Classification: E44, E47, E52

Suggested Citation

Bohl, Martin T. and Siklos, Pierre L. and Werner, Thomas, Do Central Banks React to the Stock Market? The Case of the Bundesbank. Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=459272 or http://dx.doi.org/10.2139/ssrn.459272

Martin T. Bohl (Contact Author)

University of Muenster ( email )

Schlossplatz 2
D-48149 Muenster, D-48149
Germany

Pierre L. Siklos

Wilfrid Laurier University - School of Business & Economics ( email )

Department of Economics
75 University Avenue W.
Waterloo, Ontario N2L 3C5
Canada
519-884-0710 Ext.. 3491 (Phone)

HOME PAGE: http://pierrelsiklos.com

Balsillie school of international affairs ( email )

67 Erb Street West
Waterloo, ON N2L 6C2
Canada

Thomas Werner

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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