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What explains the stock market's reaction to Federal Reserve policy?

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  • Ben Bernanke
  • Kenneth N. Kuttner

Abstract

This paper analyzes the impact of unanticipated changes in the Federal funds target on equity prices, with the aim of both estimating the size of the typical reaction, and understanding the reasons for the market's response. On average over the May 1989 to December 2001 sample, a "typical" unanticipated 25 basis point rate cut has been associated with a 1.3 percent increase in the S&P 500 composite index. The estimated response varies considerably across industries, with the greatest sensitivity observed in cyclical industries like construction, and the smallest in mining and utilities. Very little of the market's reaction can be attributed to policy's effects on the real rate of interest or future dividends, however. Instead, most of the response of the current excess return on equities can be traced to policy's impact on expected future excess returns.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2003)
Issue (Month): Mar ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2003:i:mar:x:1

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  1. Charles Evans & Kenneth Kuttner, 1998. "Can VARs describe monetary policy?," Research Paper 9812, Federal Reserve Bank of New York.
  2. Gurkaynak, Refet S. & Sack, Brian T. & Swanson, Eric P., 2007. "Market-Based Measures of Monetary Policy Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 201-212, April.
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  8. Monika Piazzesi, 2002. "The Fed and Interest Rates - A High-Frequency Identification," American Economic Review, American Economic Association, vol. 92(2), pages 90-95, May.
  9. Ehrmann, Michael & Fratzscher, Marcel, 2004. "Taking stock: monetary policy transmission to equity markets," Working Paper Series 0354, European Central Bank.
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  25. d'Amico, Stefania & Mira Farka, 2003. "The Fed and Stock Market: A Proxy and Instrumental Variable Identification," Royal Economic Society Annual Conference 2003 52, Royal Economic Society.
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