The Policy Evaluation with Channels of Influence Technique: Examination of Stock Markets Case

To show that stock prices reflect all information available including fiscal and monetary variables, we consider how budget deficits affect a financial market based on theoretical considerations and channels involved in the system. We argue that simple regression methodology is not enough to reflect all the information on stock price determination, since there exists a causal relationship among endogenous variables. To eliminate expected statistical problems, we set up a simultaneous equation model which includes fiscal as well as monetary information. Five major channels of fiscal effects on stock price determination have been hypothesized and tested. The results indicate that fiscal policy as well as monetary influences stock prices through four channels(i.e., liquidity, inflationary, psychological, and income effects).