Shadow Banking, Stock Market Volatility, and Stock-Money Market Correlation: Evidence from China

The study on the relationship between shadow banking (SB) and stock market volatility is scarce. Based on sample data from January 2006 to May 2024, this paper dives deep to clarify whether and how China's SB brings uncertainties to China's stock market and the impact of SB on the stock-money market correlation. The novelty of this paper is that we connect low-frequency SB with high-frequency financial market information under the framework of mixed-frequency data analysis. Our findings indicate that the expansion of SB could directly enhance China's stock market volatility. There exists a persistent correlation between China's stock and money markets in the long run. Furthermore, the rapid development of SB also strengthens the stock-money market correlation in the long run. Since SB could reduce the controllability of China's monetary policy and increase China's money market uncertainties, we believe that China's money market may serve as an important channel for SB to spread risks to the stock market volatility by pushing the two markets to move more closely. We shed new light on the literature regarding the relationship between SB and stock market. This paper makes the first attempt to identify the role of SB in driving the dynamics of stock-money market correlation.