Time-Varying Effects of Changes in the Interest Rate and the RMB Exchange Rate on the Stock Market of China: Evidence from the Long-Memory TVP-VAR Model

Abstract

This paper extends the TVP-VAR (time-varying parameter structural vector autoregression) (Primiceri 2005) and TVP-R (time-varying parameter autoregression) (Nakajima 2011) to the long-memory models, and uses them to investigate the time-varying effects of changes in the interest rate and renminbi (RMB) exchange rate on the Chinese stock market from July 22, 2005, to January 13, 2012. As shown in the results, the short-term effect on stock returns of changes in the RMB exchange rate is sensitive to the reform of the increasing flexibility of the RMB exchange rate. The short-term effect of interest rate changes on stock returns may be sensitive to the 2008 financial crisis. In the long term, the impact of interest rate changes on stock returns is very limited, whereas appreciation of the RMB is not an unfavorable factor for the Chinese stock market.

Keywords:

• impulse response
• long memory
• long-term equilibrium relationship
• time-varying
• TVP-VAR