An Empirical Study on the Optimal Monetary Policy and Financial Market Volatility in Egypt

This thesis comprises four empirical chapters which focus on two key economic issues in Egypt, namely the optimal monetary policy and financial market volatility. Basically, it aims at answering three main questions. (1) What is the Optimal Policy Horizon (OPH) for Inflation Targeting (IT) in Egypt in response to aggregate shocks? (2) What is the optimal policy rule for Egypt in face of aggregate and disaggregate known or unknown shocks? (3) How do monetary uncertainty, oil prices volatility and foreign stock markets volatility explain the Egyptian stock market volatility? To answer these three questions, this thesis employs a combination of well-specified and newly-developed econometric techniques as follows: 1. Chapter 2 answers the first question by minimising the Central Bank of Egypt (CBE) loss function subject to an optimal policy rule and an estimated Vector Autoregressive (VAR) model. This chapter concludes that the OPH depends mainly on the nature of the shock, the extent to which the CBE cares about other policy objective rather than inflation and the shock persistence level. 2. Regarding the second question, chapter 3 optimises again the CBE loss function but this time subject to an estimated open-economy aggregate-disaggregate structural model and six different simple policy rules to explore which rule is the optimal in face of (aggregate) disaggregate demand (supply) known or unknown shocks. The results show that exchange rate and smoothing incentive play a crucial rule in achieving the minimum loss in face of known demand and supply shocks, respectively. Moreover, a new method is suggested in this chapter to determine the optimal rule in response to any unknown shock. 3. To answer the third question, three different econometric techniques (including a new one) are applied in two chapters, 4 and 5, to explore the interdependence between stock market volatility and monetary uncertainty. These two chapter conclude a positive volatility spillovers from inflation, money supply, oil prices and foreign stock markets to the Egyptian stock market, while negative spillovers from both interest and exchange rate.