The Role of Portfolio Shocks in a Structural Vector Autoregressive Model of the Australian Economy*

Abstract

Domestic and foreign equity shocks on the Australian economy are analysed within a five‐variate structural vector autoregressive model, with identification achieved through long‐run restrictions based on the natural rate hypothesis, monetary neutrality, long‐run portfolio balance and purchasing power parity. The results show that real equity values were undervalued by 19 per cent by June 2005, with the gap narrowing thereafter. Foreign crises are important factors explaining this deterioration. The real wealth effects of equity market shocks impact significantly upon financial and goods market prices, whereas output tends to be immune. The model is also able to address puzzles that exist in the vector autoregression literature.

Overvaluation in Australian Housing and Equity Markets: Wealth Effects or Monetary Policy?*

“…Second, the long‐run restriction imposed on the housing market relating real house prices to interest rates is of a similar form to the long‐run restriction derived for equity markets by Fry et al. (2008).…”

“…To be able to quantify the size of the potential overvaluation in these markets, it is necessary to identify some ‘normal’ price that would occur if prices are solely driven by their market fundamentals. The approach adopted here is to specify a structural vector autoregression (SVAR) model of the Australian economy that combines the macroeconomic model of Fry et al. (2008), with its focus on domestic and international portfolios, with a housing sector component.…”

Output Composition of the Monetary Policy Transmission Mechanism: Is Australia Different?

“…For the purpose of this article, the recursive assumption is used for identifying the monetary policy shocks in all the VAR models, which are used by the previous studies (Angeloni et al, 2003;Fujiwara, 2004). This simple identification strategy might not be the best one for a SVAR model of Australia specifically (for which Dungey and Pagan (2000, 2009), Fry et al (2008 could be the most compelling candidates) but it might be a sound way for implementing an international comparison. Some further issues, such as the responses of net exports to a shock in monetary policy; the existence of the 'cost channel' in Australia; and the detailed effects of monetary policy on the housing market in Australiawhich need different identification schemes to be examined extensivelyare outside the scope of this article and left for future research.…”

“…Fry et al . () use a SVAR model to examine the role of portfolio shocks in Australia while Fry et al . () also use a SVAR model to investigate potential overvaluation in Australian housing and equity markets.…”

“…Some other authors such as Suzuki (2004) and Berkelmans (2005) examine the roles of each particular tool of monetary policy in Australia. Fry et al (2008) use a SVAR model to examine the role of portfolio shocks in Australia while Fry et al (2010) also use a SVAR model to investigate potential overvaluation in Australian housing and equity markets.…”