Can Institutional Integration of Western Balkans Stock Exchanges Strengthen Monetary Transmission?

TL;DR

This paper investigates how integrating Western Balkans stock exchanges affects monetary policy transmission, showing that consolidation amplifies asset-price responses to policy shocks and alters transmission sensitivity.

Contribution

It develops a counterfactual framework and empirical analysis demonstrating the impact of institutional integration on monetary transmission in small open economies.

Findings

Market integration doubles the strength of equity valuation responses to monetary shocks.

Integration increases initial pass-through of monetary policy but reduces responsiveness over time.

Consolidation leads to a new steady-state regime in monetary transmission dynamics.

Abstract

This paper asks how institutional stock-market integration reshapes the transmission of monetary policy through asset prices in small open economies. Motivated by the persistent segmentation of Western Balkan capital markets, we develop a two-stage counterfactual transmission framework to identify how stock-exchange consolidation would alter the elasticity of market valuations to monetary shocks. First, a synthetic-control simulation constructs a counterfactual integrated Western Balkan stock exchange comprising Bosnia and Herzegovina, North Macedonia, and Serbia, benchmarked to the Baltic OMX merger, thereby quantifying the structural valuation gains of institutional integration. Second, we identify exogenous monetary-policy innovations using a Taylor-rule framework augmented with inflation and output forecasts and reserve adjustments. These shocks are then embedded within a Local-Projections estimator \`a la Jord\`a (2005) to trace the dynamic responses of market capitalisation under fragmented and integrated market regimes. The results point to a systematic amplification of monetary-policy transmission through the asset-price channel once markets are unified. Following a policy tightening of about 100 basis points, equity valuations fall roughly twice as strongly under integration than under fragmented markets. Additionally, we find that integration alters the sensitivity of monetary transmission itself: the initial pass-through intensifies, but its marginal responsiveness to further integration declines over time, signalling the consolidation of a new steady-state regime.