MONETARY POLICY INDICATORS AS PREDICTORS OF STOCK RETURNS

We explore the linkage between stock return predictability and the monetary sector by examining alternative proxies for monetary policy. Using two complementary methods, we document that failure to condition on the Fed's broad policy stance causes a substantial understatement in the ability of monetary policy measures to predict returns. Industry analyses suggest that cross‐industry return differences are also linked to changes in monetary conditions, as monetary policy has the strongest (weakest) relation with returns for cyclical (defensive) industries. Overall, we find that monetary conditions have a prominent and systematic relation with future stock returns, even in the presence of business conditions.     

Nonlinear relationship between monetary policy and stock returns: Evidence from the U.S.

This paper studies the relationship between monetary policy and stock market return in the U.S. using nonlinear econometric models. It first employs a univariate Markov-switching model on each of the three stock indices and three monetary policy variables, displaying significant regime-switching patterns and common movements. This paper then uses a Markov-switching dynamic bi-factor model to simultaneously extract two latent common factors from stock indices and monetary policy variables to represent monetary policy changes and stock market movements separately. The smoothed probabilities of regimes demonstrate that expansionary monetary policy regimes follow economic recessions, but bear stock markets usually occur before economic recessions. The maximum likelihood estimation results show that expansionary monetary policy such as a decrease in the federal funds rate raises stock returns, but stock returns don't directly influence monetary policy decision.     

A study of cross-industry return predictability in the Chinese stock market

We investigate cross-industry return predictability for the Shanghai and Shenzhen stock exchanges, by constructing 6- and 26- industry portfolios. The dominance of retail investors in these markets, in conjunction with the gradual diffusion of information hypothesis provide the theoretical background that allows us to employ machine learning methods to test for cross-industry predictability. We find that Oil, Telecommunications and Finance industry portfolio returns are significant predictors of other industries. Our out-of-sample forecasting exercise shows that the OLS post-LASSO estimation outperforms a variety of benchmarks and a long–short trading strategy generates an average annual excess return of 13%.     

Market States and the Effect on Equity REIT Returns due to Changes in Monetary Policy Stance

This study investigates the effect of changes in monetary policy on US equity real estate investment trust (EREIT) returns in lower and higher return ranges during bull, bear, and volatile stock market states using quantile regression. Results show that EREIT returns are sensitive to changes in monetary policy at different EREIT return ranges in different market states. During bull markets, changes in monetary policy have a significant negative impact on EREIT when investors have lower expectations of real estate price increases, but are not effective when investors have higher expectations of real estate price increases. During volatile and bear markets, EREIT returns are not sensitive to changes in monetary policy stance. Results also show that EREIT returns respond positively to stock returns in various states and conditions.     

Monetary environments and stock returns: International evidence based on the quantile regression technique

This paper investigates the impact of the local and the US monetary policy environments on stock returns at the different locations on the return distributions. Using data for stock returns and interest rates of 30 countries, the quantile regression technique is employed to estimate the sensitivity of the returns to monetary policy at the different points on the return distributions. The results suggest that higher returns are associated with expansionary monetary policy. Furthermore, some of the stock markets in the sample are found to react to the local, but not the US monetary environments at the lower quantiles while the response at the higher quantiles appears to be sensitive to the US, but not the local monetary conditions. These findings are further supported by the slope equality tests, discussed in Koenker & Bassett (1982), and the analysis of weighted absolute residuals (ANOWAR), proposed by Chen, Ying, Zhang, & Zhao (2008).     

Stock Return Predictability and The Role of Monetary Policy

This article examines whether shifts in the stance of monetary policy can account for the observed predictability in excess stock returns. Using long-horizon regressions and short-horizon vector autoregressions, the article concludes that monetary policy variables are significant predictors of future returns, although they cannot fully account for observed stock return predictability. I undertake variance decompositions to investigate how monetary policy affects the individual components of excess returns (risk-free discount rates, risk premia, or cash flows).     

The reaction of international stock markets to Federal Reserve policy

This paper investigates how changes in Federal Reserve policy impact international stock returns, with the three objectives of measuring the reaction of international stock markets, understanding the transmission channels of that reaction, and explaining the economic sources of that reaction. We find that unanticipated Federal Reserve policy actions exert a significant and robust influence on international stock prices. However, the influence of unanticipated monetary policy actions is not strong enough to change the correlation structure of international equity returns. We also find that international stock return co-movements play an important role in the transmission of monetary policy. Finally, the variance decomposition analysis indicates that the effects of monetary policy surprises on future excess returns or dividend returns account for the largest portion of the equity price response.     

Dynamic Interactions among the Stock Market,Federal Funds Rate,Inflation, and Economic Activity

This paper examines the dynamic interactions among the equity market, economic activity, inflation, and monetary policy under three monetary policy regimes using bivariate and multivariate vector autoregressive cointegrating specifications. The bivariate results for the real stock returns‐inflation pair weakly support a negative correlation in the 1970s and 1980s. While the bivariate findings suggest a weak, negative relationship between real returns and the federal funds in the 1970s and 1980s, the multivariate findings strongly support short‐term linkages in the 1970s. There appears to be no consistent dynamic relationship between monetary policy and stock prices in that the relationship differs across monetary regimes.     

On Stock Market Returns and Monetary Policy

Financial economists have long debated whether monetary policy is neutral. This article addresses this question by examining how stock return data respond to monetary policy shocks. Monetary policy is measured by innovations in the federal funds rate and nonborrowed reserves, by narrative indicators, and by an event study of Federal Reserve policy changes. In every case the evidence indicates that expansionary policy increases ex-post stock returns. Results from estimating a multi-factor model also indicate that exposure to monetary policy increases an asset's ex-ante return.     

Simultaneous monetary policy announcements and international stock markets response: An intraday analysis

This paper investigates the return and volatility response of major European and US equity indices to monetary policy surprises by utilizing extensive intraday data on 5-min price quotes along with a comprehensive dataset on monetary policy decisions and macroeconomic news announcements. The results indicate that the monetary policy decisions generally exert immediate and significant influence on stock index returns and volatilities in both European and the US markets. The findings also show that press conferences held by the European Central Bank (ECB) that follow monetary policy decisions on the same day have a clear impact on European index return volatilities. This implies that they convey additional important information to market participants. Overall, our analysis suggests that the use of high frequency data is critical to separate the effect of monetary policy actions from those of macroeconomic news announcements on stock index returns and volatilities.     

Does institutional ownership matter for international stock return comovement?

We study the link between international stock return comovements and institutional investment. We test whether the rise of institutional ownership has increased cross-country correlations and decreased cross-industry correlations. Using stock-level institutional holdings across 45 countries during the 2001–2010 period, we find that industry and global factors are relatively more important the country factors in explaining stock return variation among stocks with higher institutional ownership. Industry diversification strategies are more beneficial than country diversification strategies for stocks with high institutional ownership. We show that cross-border portfolio investment is a powerful force of international capital market integration and convergence of asset prices.     

New return anomalies and new-Keynesian ICAPM

I propose a new multi-factor asset pricing model with new-Keynesian factors to explain stock return anomalies from 1972Q1 to 2009Q2. This new model explains the average returns across testing portfolios formed on financial distress, momentum, and standardized unexpected earnings with misspecification-robust statistics. Test portfolios formed on net stock issues and total accruals are also partly explained by new-Keynesian factors. Two monetary policy factors play an important role in explaining these new anomalies. The credit aspect of these new anomalies suggests an economic rationale for the model through capital market imperfections and the credit channel of monetary policy mechanism.     

What determines the stock market's reaction to monetary policy statements?

We find that information communicated through monetary policy statements has important business cycle dependent implications for stock prices. For example, during periods of economic expansion, stocks tend to respond negatively to announcements of higher rates ahead. In recessions, however, we find a strong positive reaction of stocks to seemingly similar signals of future monetary tightening. We provide evidence that the state dependence in the stock market's response is explained by information about the expected equity premium and future corporate cash flows contained in monetary policy statements. We also show state dependence in the average stock returns on days of scheduled FOMC meetings and in the impact of monetary policy statements on stock and bond return volatility.     

货币政策公告、政策不确定性及股票市场的预公告溢价效应——来自中国市场的证据

中国人民银行周期性发布的货币政策相关公告为市场判断货币政策走向提供重要信息。较于实体经济反馈政策信息具有滞后性,股票市场是否在货币政策公告期内及时对政策消息做出反应,即存在公告效应？股票价格是否体现预期货币政策调整带来的不确定性？本文基于2011-2017年A股市场数据,研究我国股票市场在我国货币政策相关公告发布前后几日这一较短窗口区间内的市场反应。结果表明,股市指数在发布货币供应量指标的公告前几天内会出现显著为正的风险溢价,而在指标发布后溢价并不显著,这一现象我们称之为货币政策相关公告的“预公告溢价效应”。本文发现,预公告溢价的产生并非由于市场提前预期到货币政策的走向,而是来源于投资者预先获得了对政策不确定性的溢价补偿。本文进一步就防范系统性风险、从数量型货币政策工具向价格型转变等问题提出了相关政策建议。     

The impact of monetary policy surprises on asset return volatility: the case of Germany

This paper investigates the impact of monetary policy surprises by the FED or Bundesbank/ECB on the return volatility of German stocks and bonds using a GARCH-M model. We show that stock return volatility is susceptible to monetary policy surprises in the United States, whereas monetary policy surprises in the Euro zone matter for bond return volatility. These findings are robust for other Euro zone stock markets, but not significant for other Euro zone bond markets. The empirical evidence also suggests that monetary policy surprises have larger effects on German stock return volatility in bear markets than in bull phases. Moreover, our results support the claim that stock return volatility can be negatively correlated with stock returns, contradicting predictions made by many asset pricing models (e.g., CAPM or ICAPM) and the empirical finding of an insignificant relationship often reported in the literature.

Monetary policy and stock returns: Financing constraints and asymmetries in bull and bear markets

We examine asymmetries in the impact of monetary policy surprises on stock returns between bull and bear markets in the period 1994 to 2005. We ask how these impacts respond to the relative ability of firms to obtain external finance. We find that the impact of a surprise monetary policy in a bear market is large, negative, and statistically significant, and this holds across size decile portfolios. The impact of a surprise policy action in a bear market for most industries is significantly greater than the impact of surprise monetary policy in a bull market. Controlling for the capacity for external finance, stock returns of firms in bear states respond more than firms in bull states. Capacity for external finance is more important in a bear market, as it partially mitigates the larger impact of monetary policy in a bear market.     

Stock Market Reaction to Monetary Policy: An Event Study Analysis of the Brazilian Case

This article examines the relationship between the monetary policy implemented by the Central Bank of Brazil and the stock market. We implement event study analysis and analyze the effect of the anticipated and unanticipated components of monetary policy decisions on the returns of the IBOVESPA index and 53 stocks. We find that monetary policy has a significant effect on the stock market, but is only responsible for a small proportion of market variation. The analysis at the sector level with expected returns identifies that the financial sector is the most affected by this policy, whereas with excess returns only industrial goods are significantly affected. Moreover, individual assets respond in a rather heterogeneous fashion to monetary policy; however, when we look at excess returns, we identify a reduction in the intensity and in the number of companies impacted by monetary policy. Finally, the monetary shock is explained by unanticipated variations in the unemployment rate, in the Industrial Production Index, in the General Market Price Index, and in the Broad Consumer Price Index.     

Modeling Time-Varying Volatility and Expected Returns: Evidence from the GCC and MENA Regions

The aim of this study is to investigate empirically the underlying nexus of stock market returns and volatility in the Gulf Cooperation Council (GCC) countries and Middle East and North Africa (MENA) region by using the GARCH-M model. We find that volatility is time-varying in all countries, which indicates substantial variation in the degree of risk across time. However, we do not find empirical support that this time-varying volatility significantly explains expected returns, except in the case of Kuwait, United Arab Emirates, and the MENA region portfolio. Our findings show that stock return volatility is negatively correlated with stock returns in these three markets under the assumption of investor risk aversion. This lends some support to the hypothesis of a volatility-driven negative relationship in the literature. The policy implications of our results are discussed.     

Real Activity, Inflation, Stock Returns, and Monetary Policy

We find that contractionary monetary policy shocks generate statistically significant movements in inflation and expected real stock returns, and that these movements go in opposite directions. Since positive shocks to output precipitate monetary tightening, we argue that the countercyclical monetary policy process is important in explaining the negative correlation between inflation and stock returns. Examining the 1979–1982 period, we find that monetary policy tightens significantly in response to positive shocks to inflation, and that the impact of monetary policy shocks on stock returns is negative and volatile. Therefore, we see evidence that an “anticipated policy” hypothesis is at work.     

Are common stocks a good hedge against inflation? Evidence from the Pacific-rim countries

We explore whether the observed real stock return–inflation relations in the U.S. and 10 Pacific-rim countries for the sample period of 1970–1997 can be explained by the interaction between real and monetary disturbances. Ten countries exhibit a negative relation between real stock returns and inflation. Malaysia is the only country that exhibits a positive relation. For nine countries, real output disturbances drive a negative stock return–inflation relation, while monetary disturbances yield a positive relation. In addition, real shock components appear to be relatively more important than monetary shock components for these countries, and as a result the observed relation between stock returns and inflation is negative. Neither the tax hypothesis nor the monetary regime hypothesis seems to be easily compatible with the diverse experiences of the Pacific-rim countries.