Abstract

Monetary decisions affect firms' cash flows and the level of interest rate which in turn will affect the stock price. There are many articles which analyze the relationship between local monetary policy and stock returns and find that an expansive monetary policy increases stock returns. Some of these articles extend the analysis to the relationship between the international monetary environment and stock returns. However, all of these articles assume the error variance to be constant, i.e., the articles use homoscedastic models instead of more general heteroscedastic models. This thesis extends the existing literature in several ways. Firstly, the generalized autoregressive conditional heteroscadestic models (GARCH) instead of homoscedastic models are used in the analysis of the relationship between the stock returns and monetary variables. Secondly, the analysis is further extended by using more sophiscated models like GARCH-M and GARCH-M with spillover effect. In this study, four countries (France, the U.K., Germany, and Japan) are analyzed. The impact of the US monetary policy is included in the analysis that represents the impact of international monetary environment. Finally, a vector autoregressive (VAR) model is used in order to account for the dynamic relationship among the monetary variables. It is found that, in the case of every country, the excess stock returns are significantly affected by both the local and the U.S. monetary environment, although significance varies according to time period and the specification of variance. The results from the VAR model indicate that stock returns in different countries react differently to the changes in the US monetary