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On money supply and asset prices: A study of an idealised market game and its implications
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School of Business |
Master's thesis
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en
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57+24
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The quantity theory of money is one of the oldest theories in economics. In Finance, the financial newspapers take it for granted that it is true in the asset market. However, there is little academic research done to verify that the theory would hold.
This Thesis seeks to explain the interrelationship of the money supply and the asset prices. We formulate a game of an idealised market with an interpretation of rational investors as wide as possible and study it. The study confirms that asset prices should correlate with the money supply.
Data from the World Bank is analysed to confirm that the correlation exists. Results are weak but align with previous research. The customer price index (Boudoukh and Richardson, 1993) and gross domestic product (Swinkels and Umlauft, 2022) have weak or negative connections to asset returns in the short term. In the long term, they do correlate significantly. We recognise that any two variables with a trend will correlate. Therefore, we leave our results inconclusive.
The study of the game reveals that market capitalisation depends on the money supply in the market. Assets in the market are in a zero-sum game. The market conditions should impact equity returns more than the expected profits of companies. The author considers that academic literature emphasises the modern portfolio theory at the expense of other modus operandi. The banking and insurance industries hold vast capital holdings. They are known to apply the dedicated portfolio theory and complex value-at-risk models. This Thesis finds that these may explain many phenomena observed in the asset markets.