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

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Author Info
Ben Bernanke
Kenneth N. Kuttner

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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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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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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. John H. Boyd & Ravi Jagannathan & Jian Hu, 2001. "The Stock Market's Reaction to Unemployment News: Why Bad News is Usually Good for Stocks," NBER Working Papers 8092, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2002. "Market-based measures of monetary policy expectations," Finance and Economics Discussion Series 2002-40, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  3. Demiralp, Selva & Jorda, Oscar, 2004. "The Response of Term Rates to Fed Announcements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 387-405, June.
  4. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94. [Downloadable!]
  5. Charles L. Evans & Kenneth N. Kuttner, 1998. "Can VAR's describe monetary policy?," Working Paper Series WP-98-19, Federal Reserve Bank of Chicago. [Downloadable!]
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  6. Jon Faust & Eric Swanson & and Jonathan H. Wright, 2002. "Identifying vars based on high frequency futures data," International Finance Discussion Papers 720, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  7. Christina D. Romer & David H. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June. [Downloadable!] (restricted)
  8. Ray C. Fair, 2002. "Events That Shook the Market," Journal of Business, University of Chicago Press, vol. 75(4), pages 713-732, October. [Downloadable!]
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  9. Joel T. Krueger & Kenneth N. Kuttner, 1995. "The Fed funds futures rate as a predictor of Federal Reserve policy," Working Paper Series, Macroeconomic Issues 95-4, Federal Reserve Bank of Chicago.
  10. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April. [Downloadable!] (restricted)
  11. John Y. Campbell & Tuomo Vuolteenaho, 2003. "Bad Beta, Good Beta," NBER Working Papers 9509, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
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  13. Brandt, Michael W. & Wang, Kevin Q., 2003. "Time-varying risk aversion and unexpected inflation," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1457-1498, October. [Downloadable!] (restricted)
  14. Campbell, John Y & Ammer, John, 1993. " What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March. [Downloadable!] (restricted)
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  15. Shingo Goto, 2000. "The Fed's Effect on Excess Returns and Inflation is Much Bigger Than You Think," University of California at Los Angeles, Anderson Graduate School of Management 1058, Anderson Graduate School of Management, UCLA. [Downloadable!]
  16. John H. Cochrane & Monika Piazzesi, 2002. "The Fed and Interest Rates: A High-Frequency Identification," NBER Working Papers 8839, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, vol. 52(2), pages 635-54, June. [Downloadable!] (restricted)
  18. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series 2002-4, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  19. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 639-669, May. [Downloadable!] (restricted)
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  20. Jon Faust & Eric Swanson & Jonathan Wright, 2004. "Do Federal Reserve Policy Surprises Reveal Superior Information about the Economy?," Contributions to Macroeconomics, Berkeley Electronic Press, vol. 4(1), pages 1246-1246. [Downloadable!] (restricted)
  21. Michael Ehrmann & Marcel Fratzscher, 2004. "Taking stock: monetary policy transmission to equity markets," Working Paper Series 354, European Central Bank. [Downloadable!]
  22. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March. [Downloadable!] (restricted)
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  23. 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. [Downloadable!]
  24. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings, Federal Reserve Bank of Kansas City, pages 77-128. [Downloadable!]
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  25. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June. [Downloadable!] (restricted)
  26. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June. [Downloadable!] (restricted)
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