Analysis of the Effects of Governance Index, Credit Risk, and Monetary Policy Shocks on Stock Returns in Recession and Boom Regimes of Iran
Keywords:
governance, risk aversion, monetary policy shocks, stock returns, Markov switching regime change modelAbstract
Objective: This study aims to examine the effects of governance quality, credit risk, and monetary policy shocks on stock returns in Iran across recessionary and expansionary regimes.
Methodology: This quantitative study employs annual macroeconomic data for Iran covering the period 1996–2022. To capture nonlinear dynamics and regime-dependent behavior in stock returns, a Markov Switching regime model is applied. The dependent variable is total stock market return, while the explanatory variables include the governance index, credit risk, monetary policy shocks, exchange rate volatility, the degree of central bank intervention, and financial crisis episodes. Unit root tests and likelihood ratio tests were conducted to ensure stationarity and justify the nonlinear modeling framework, after which a two-regime model representing recession and boom phases was estimated.
Findings: The results indicate that during expansionary regimes, improvements in governance quality, increases in credit risk, monetary policy shocks, exchange rate volatility, central bank intervention, and financial crises exert positive and statistically significant effects on stock returns. In recessionary regimes, exchange rate volatility remains positively and significantly associated with stock returns, whereas the effects of other variables are weaker or insignificant. Transition probabilities suggest higher persistence in the expansionary regime, and the estimated variance of disturbances is substantially larger during recessions than during booms.
Conclusion: Overall, the findings highlight that institutional quality, monetary policy conditions, and exchange rate dynamics play critical roles in shaping stock market performance in Iran, with their impacts varying across business cycle regimes.
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