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Taking stock: monetary policy transmission to equity markets

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Author Info
Michael Ehrmann () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt/Main, Germany;)
Marcel Fratzscher () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt/Main, Germany;)

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Abstract

This paper analyses the effects of US monetary policy on stock markets. We find that, on average, a tightening of 50 basis points reduces returns by about 3%. Moreover, returns react more strongly when no change had been expected, when there is a directional change in the monetary policy stance and during periods of high market uncertainty. We show that individual stocks react in a highly heterogeneous fashion and relate this heterogeneity to financial constraints and Tobin's q. First, we show that there are strong industry-specific effects of US monetary policy. Second, we find that for the individual stocks comprising the S&P500 those with low cashflows, small size, poor credit ratings, low debt to capital ratios, high price-earnings ratios or high Tobin's q are affected significantly more. The use of propensity score matching allows us to distinguish between firmand industry-specific effects, and confirms that both play an important role.

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Paper provided by European Central Bank in its series Working Paper Series with number 354.

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Length: 46 pages
Date of creation: May 2004
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Handle: RePEc:ecb:ecbwps:20040354

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Related research
Keywords: monetary policy stock market credit channel Tobin’s q financial constraints S&P500 propensity score matching.

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Find related papers by JEL classification:
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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References listed on IDEAS
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. Dedola, Luca & Lippi, Francesco, 2000. "The Monetary Transmission Mechanism: Evidence from the Industries of Five OECD Countries," CEPR Discussion Papers 2508, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March. [Downloadable!] (restricted)
  3. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 1027-1057, October. [Downloadable!] (restricted)
  4. Rajeev H. Dehejia & Sadek Wahba, 2002. "Propensity Score-Matching Methods For Nonexperimental Causal Studies," The Review of Economics and Statistics, MIT Press, vol. 84(1), pages 151-161, February. [Downloadable!] (restricted)
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  5. Ehrmann, Michael & Fratzscher, Marcel, 2003. "Monetary Policy Announcements and Money Markets: A Transatlantic Perspective," International Finance, Blackwell Publishing, vol. 6(3), pages 309-28, Winter. [Downloadable!] (restricted)
  6. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers 02-16, Duke University, Department of Economics. [Downloadable!]
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  7. Ben S. Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Staff Reports 174, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  8. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation, Yale University. [Downloadable!]
  9. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  10. Willem H. Buiter, 2003. "James Tobin: An Appreciation of his Contribution to Economics," Economic Journal, Royal Economic Society, vol. 113(491), pages F585-F631, November. [Downloadable!] (restricted)
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  11. Ignazio Angeloni & Michael Ehrmann, 2003. "Monetary policy transmission in the euro area: any changes after EMU?," Working Paper Series 240, European Central Bank. [Downloadable!]
  12. Selva Demiralp & Òscar Jordà, 2002. "The announcement effect: evidence from open market desk data," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 29-48. [Downloadable!]
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  13. Conover, C. Mitchell & Jensen, Gerald R. & Johnson, Robert R., 1999. "Monetary environments and international stock returns," Journal of Banking & Finance, Elsevier, vol. 23(9), pages 1357-1381, September. [Downloadable!] (restricted)
  14. Fama, Eugene F & French, Kenneth R, 1995. " Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-55, March. [Downloadable!] (restricted)
  15. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February. [Downloadable!] (restricted)
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  16. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September. [Downloadable!] (restricted)
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  17. Michael Ehrmann & Marcel Fratzscher, 2002. "Interdependence between the euro area and the US: what role for EMU?," Working Paper Series 200, European Central Bank. [Downloadable!]
Full references

Cited by:
(explanations, 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. Reint Gropp & Arjan Kadareja, 2007. "Stale information, shocks and volatility," Working Paper Series: Finance and Accounting 173, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
    Other versions:
  2. Ben S. Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Staff Reports 174, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  3. Chulia-Soler, H & Martens, M.P.E. & Dijk, D.J.C. van, 2007. "The Effects of Federal Funds Target Rate Changes on S&P100 Stock Returns, Volatilities, and Correlations," Research Paper ERS-2007-066-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
  4. Michael Ehrmann & Marcel Fratzscher & Roberto Rigobon, 2005. "Stocks, Bonds, Money Markets and Exchange Rates: Measuring International Financial Transmission," NBER Working Papers 11166, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Albuquerque, Rui & Vega, Clara, 2006. "Asymmetric Information in the Stock Market: Economic News and Co-movement," CEPR Discussion Papers 5598, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  6. P. Siklos, M. Bohl, 2006. "Policy Words and Policy Deeds: The ECB and the Euro," Working Papers eg0050, Wilfrid Laurier University, Department of Economics, revised 2006. [Downloadable!]
    Other versions:
  7. Joshua Hausman & Jon Wongswan, 2006. "Global asset prices and FOMC announcements," International Finance Discussion Papers 886, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Michael Ehrmann & Marcel Fratzscher, 2006. "Global financial transmission of monetary policy shocks," Working Paper Series 616, European Central Bank. [Downloadable!]
    Other versions:
  9. Bjørnland , Hilde & Leitemo, Kai, 2005. "Identifying the interdependence between US monetary policy and the stock market," Research Discussion Papers 17/2005, Bank of Finland. [Downloadable!]
    Other versions:
  10. Michael Ehrmann & Marcel Fratzscher, 2007. "Explaining monetary policy in press conferences," Working Paper Series 767, European Central Bank. [Downloadable!]
  11. Aaron Drew & Özer Karagedikli, 2008. "Some benefits of monetary policy transparency in New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2008/01, Reserve Bank of New Zealand. [Downloadable!]
    Other versions:
  12. Özer Karagedikli & Pierre L. Siklos, 2008. "Explaining Movements in the NZ Dollar - Central Bank Communication and the Surprise Element in Monetary Policy?," Reserve Bank of New Zealand Discussion Paper Series DP2008/02, Reserve Bank of New Zealand. [Downloadable!]
  13. Coricelli, Fabrizio & Égert, Balázs & MacDonald, Ronald, 2006. "Monetary transmission mechanism in Central and Eastern Europe: Gliding on a wind of change," BOFIT Discussion Papers 8/2006, Bank of Finland, Institute for Economies in Transition. [Downloadable!]
  14. Lucía Cuadro Sáez & Marcel Fratzscher & Christian Thimann, 2007. "The transmission of emerging market shocks to global equity markets," Banco de España Working Papers 0727, Banco de España. [Downloadable!]
    Other versions:
  15. Jon Wongswan, 2005. "The response of global equity indexes to U.S. monetary policy announcements," International Finance Discussion Papers 844, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  16. Michael Ehrmann & Marcel Fratzscher, 2005. "Transparency, disclosure and the Federal Reserve," Working Paper Series 457, European Central Bank. [Downloadable!]
    Other versions:
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