INTEREST RATE CHANGES AND COMMON STOCK RETURNS OF FINANCIAL INSTITUTIONS: REVISITED

In this paper the interest rate sensitivity of common stock returns of financial firms is re-examined. Considered here are (1) current, anticipated, and unanticipated changes in interest rates; (2) depository and nondepository firms; and (3) three different-maturity interest rate indices. Results lend strong support for a negative effect of both current and unanticipated interest rate changes. Although some exceptions are observed, stock returns of most subsectors of both financial and nonfinancial firms are not sensitive to anticipated interest rate changes. The findings of this study are robust to the choice of a particular model of interest rate expectations.     

PRESIDENTIAL ELECTION UNCERTAINTY AND COMMON STOCK RETURNS IN THE UNITED STATES

There is substantial evidence on the influence of political outcomes on the business cycle and stock market. We further hypothesize that uncertainty about the outcome of a U.S. presidential election should be reflected in pre‐election common stock returns. Prior research pools returns based on the party of the winning candidate, assuming that the outcome of the election is known a priori. We use candidate preference (i.e., polling) data to construct a measure of election uncertainty. We find that if the election does not have a candidate with a dominant lead, stock market volatility (risk) and average returns rise.     

STOCK PRICE AND DEGREE OF NEGLECT AS DETERMINANTS OF STOCK RETURNS

In prior research the neglected firm effect persists even after controlling for firm size. Several recent studies show that the size effect is a stock price effect. In the present study we investigate whether excess returns on neglected stocks are a manifestation of a stock price effect. Although material evidence supporting an independent neglected firm effect is still found, results are much weaker than in prior studies. Examining a large sample of New York Stock Exchange and American Stock Exchange stocks from 1977 to 1988, we find that both January and non-January months do not have a statistically significant neglect effect after controlling for a price effect.     

COMMON STOCK RETURNS,EXPECTED INFLATION,AND THE RATIONAL EXPECTATIONS HYPOTHESIS

This paper provides empirical evidence that expected inflation has a cross-sectional impact on common stock returns. The study differs from others in that (a) the relation between stock returns and expected inflation is investigated in a two-factor asset pricing model, where the factors are the return on an equally weighted stock portfolio and the expected rate of inflation; (b) the estimation of the expected rate of inflation is based on the rational expectations hypothesis of Muth; and (c) a non-linear seemingly unrelated regression technique is employed to determine consistent and asymptotically efficient estimates. The joint hypothesis of the two-factor asset pricing model and rational expectations is not rejected in this study. It is found that the return on common stocks is significantly affected by expected inflation. Also stocks whose returns are positively correlated with expected inflation have lower expected returns.     

THE INTERACTION OF MONETARY POLICY AND STOCK RETURNS

The “irrational exuberance” of the stock market in the late 1990s led to a discussion of the appropriate policy response by monetary authorities. Any response would be contingent on the stock market reaction to policy shocks. In this study, I employ a structural vector autoregression to estimate the response of the stock market returns to innovations in the federal funds rate. The role of the stock market in the Federal Reserve policy rule can also be examined empirically.