Monetary policy surprises and firm-level stock return predictability: evidence from a new panel-based approach

We employ a new panel-based testing procedure that is robust to the uncertain persistence of regressors, time-varying volatility and cross-sectional error dependence in studying the predictive dynamics between conventional US monetary policy surprises and firm-level stock returns. We find that accounting for cross-sectional dependence by means of (estimated) factors considerably alters the predictive significance of monetary policy surprises depending on the sample period being studied. Concretely, during the period 1990–2000, monetary policy has no influence on future stock returns when cross-sectional dependence is accounted for by means of common factor augmentation. By contrast, the predictive power of monetary policy is even boosted when introducing common factors into the model when the period of analysis covers 2002–2007.