An Empirical Study On Investor Sentiment On China's Monetary Policy Transmission

Monetary policy transmission has been one of the most important parts in the field of monetary policy research. Under the assumptions of rational investors and efficient market, the traditional monetary policy transmission theory suggests that monetary policy can transmit to the real economic activity through interest rate channel, asset price channel and credit channel in order to achieve the two goals:price stability and economic growth. Moreover, economists in this field all emphasized the expectations of the public (or the market) is one of the important determinants of the monetary policy efficiency. With the development of behavioral finance theory, professionals argued that investor sentiment will change the volatility of financial markets and investment behaviors. Studies have shown that consumers, businesses and investors’ confidence has broadened the impact of the financial crisis since the2008. Developing the research of role of the investor sentiment in the transmission of monetary policy is helpful to the decision-making of the central bank and the prediction of investors.This paper tries to start from studying the investor sentiment and the traditional theory of monetary policy transmission, and then discuss the relationship between investor sentiment and monetary policy transmission further. So the paper focuses on the definition and measurement of investor sentiment in the beginning, then through the review and collation of traditional monetary policy transmission theory, discusses the role of investor sentiment in the transmission process of monetary policy. This thesis also employs two structural factor-augmented vector autoregressive models to investigate how the market emotion affects on the performance of monetary policy in China. The empirical results show that with sentiment factor in the model, the monetary policy has shorter time lag than the model without sentiment factor. Further results also show that without sentiment factor, the explanatory power of monetary factors on the volatility of real activity factor, inflation factor and other factors decreased sharply, indicating that the investor sentiment plays a enhancer role of the monetary policy transmission.