This study is concerned with the relationship between the change of money stocks and stock returns. It examines stock market efficiency with respect to money supply data and the direction of stock returns over changes in money growth rates by testing regression models of stock returns on monetary variables.
To analyse the relationship between changes in the rate of the money supply and stock returns, regression models using lagged variables are formulated. This empirical analysis used seasonally adjusted data of money stock growth and the composite stock price index during the 1975 to the 1984 period.
The evidence indicates (1) the meaningful lag in the effect of monetary policy on the stock market and (2) positive relations between money stocks and stock returns. Therefore this evidence is inconsistent with the efficient market model. Current security returns don't incorporate all information contained in past money supply stock and, in addition, don't appear to anticipate future changes in the money supply. This result is different from that of the stock markets in New York.
In addition, M2 is superior to other indexes (reserve money, M1) with relation to stock returns.
In conclusion, the evidence is consistent with the predictive form of the monetary portfolio adjustment model in Korea. For Korean stock market, the trading rules using past values of the money supply would be more profitable than the Buy & Hold policy.