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Does monetary policy affect stock prices and Treasury yields? An error correction and simultaneous equation approach

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  • J. Benson Durham

Abstract

This study pursues two addenda to the practitioner and academic on the effect of monetary policy on asset prices. First, this paper applies cointegration theory, and, second, relaxes the stringent assumption in the literature that changes in 10-year Treasury yields, stock returns, and changes in the stance of monetary policy are exogenous. Given quarterly data from 1978:Q4 to 2002:Q3, two-stage least squares (2SLS) regressions suggest that changes in the exogenous component of the federal funds rate affect changes in Treasury yields but not stock returns, ceteris paribus. However, this result is sensitive to alternative proxies for the stance of monetary policy. Also, little evidence suggests that monetary policy responds to the exogenous components of changes in financial asset prices.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-10.

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Date of creation: 2003
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Handle: RePEc:fip:fedgfe:2003-10

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Keywords: Capital ; Prices ; Monetary policy;

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References

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  1. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Technical Working Papers 0100, National Bureau of Economic Research, Inc.
  2. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-88, October.
  3. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
  4. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 869-902, August.
  5. Granger, Clive W J, 1986. "Developments in the Study of Cointegrated Economic Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 213-28, August.
  6. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  7. Durham, J. Benson, 2001. "Sensitivity analyses of anomalies in developed stock markets," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1503-1541, August.
  8. J. Benson Durham, 2001. "The effect of monetary policy on monthly and quarterly stock market returns: cross-country evidence and sensitivity analyses," Finance and Economics Discussion Series 2001-42, Board of Governors of the Federal Reserve System (U.S.).
  9. 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.
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Cited by:
  1. Ansgar Belke & Thorsten Polleit, 2006. "Dividend Yields for Forecasting Stock Market Returns. An ARDL Cointegration Analysis for Germany," Ekonomia, Cyprus Economic Society and University of Cyprus, vol. 9(1), pages 86-116, Summer.
  2. Ansgar Belke & Thorsten Polleit, 2005. "Monetary Policy and Dividend Growth in Germany: Long-Run Structural Modelling versus Bounds Testing Approach," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 250/2005, Department of Economics, University of Hohenheim, Germany.
  3. Ansgar Belke & Marcel Wiedmann, 2013. "Money, Stock Prices and Central Banks – Cross-Country Comparisons of Cointegrated VAR Models," ROME Working Papers 201308, ROME Network.
  4. Ansgar Belke & Marcel Wiedmann, 2013. "Monetary Policy, Stock Prices and Central Banks - Cross-Country Comparisons of Cointegrated VAR Models," Ruhr Economic Papers 0435, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  5. He, Ling T., 2006. "Variations in effects of monetary policy on stock market returns in the past four decades," Review of Financial Economics, Elsevier, vol. 15(4), pages 331-349.
  6. Ansgar Belke & Thorsten Polleit, 2005. "(How) Do Stock Market Returns React to Monetary Policy? - An ARDL Cointegration Analysis for Germany," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 253/2005, Department of Economics, University of Hohenheim, Germany.

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