The money multiplier and asset returns

Thesis

In recent years, we have lived through times of unprecedented money and credit creation, which has prompted a new interest in the role of money and credit in the economy. In this work, I show that the money multiplier, the ratio of a broad monetary aggregate to a narrow monetary aggregate, captures the rate of money creation in the economy and robustly predicts stock, bond and currency returns. I link the predictive ability of the money multiplier to its economic interpretations as a measure of economy-wide leverage and an alternative measure of money velocity.

First, I look at U.S. stock and bond market and show that money multipliers robustly predict stock and bond excess returns over the period January 1959 - December 2015, and are priced in cross-section of stocks. These multipliers remain statistically significant after controlling for outside money growth and other well- understood predictors of stock and bond returns.

Then I extend my analysis to currencies. I investigate short-run and long-run relationships between bilateral exchange rates and broad money multipliers of ten countries. I motivate my analysis with the quantity theory of money and find a strong long-run relationship between the exchange rate, relative money velocities, relative money supplies of the two countries and their relative output. I argue that the money multiplier can be seen as an alternative measure for money velocity, as it accounts for propensity to spend money not only on real sector goods and services but on financial assets too.

Authors: Stepashova, A

• Type of award: DPhil
• Level of award: Doctoral
• Awarding institution: University of Oxford
• Language: English
• Keywords: return predictability; macro finance; money multiplier; empirical asset pricing
• Subjects: Financial Economics; Empirical Finance