Measuring Response of Stock Market to Central Bank Independence Shock

Abstract

This paper examines the responses of stock traded and economic activity in relation to central bank independence shocks. The analysis is based on a panel Vector Autoregressive estimation covering 25 developing countries for a quarterly period between 1990 Q1 and 2021 Q4. Panel VAR estimation is known to be potentially biased in a dynamic panel data model if the coefficient on the endogenous variables differs across countries. To test the pooling assumption of the model, this paper applies the Chow and Roy-Zellner tests. The results establish that the models contain the heterogeneity among samples; thus, mean-group estimation for panel VAR is performed as a solution for heterogeneity problem. The results show that there is a delayed effect of CBI to increase stock traded. This demonstrates that CBI takes around six quarters to strengthen the financial market. By dividing the sample into two groups, we find that CBI has a different effect on stock traded for countries that have high and low stock traded.