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What Explains the Stock Market's Reaction to Federal Reserve Policy?

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  • Ben S. Bernanke
  • Kenneth N. Kuttner

Abstract

This paper analyzes the impact of changes in monetary policy on equity prices, with the objectives both of measuring the average reaction of the stock market and also of understanding the economic sources of that reaction. We find that, on average, a hypothetical unanticipated 25-basis-point cut in the federal funds rate target is associated with about a one percent increase in broad stock indexes. Adapting a methodology due to Campbell (1991) and Campbell and Ammer (1993), we find that the effects of unanticipated monetary policy actions on expected excess returns account for the largest part of the response of stock prices.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10402.

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Date of creation: Apr 2004
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Publication status: published as Bernanke, Ben S., and Kenneth N. Kuttner. "What Explains the Stock Market's Reaction to Federal Reserve Policy?" Journal of Finance 60(3): 1221-1257, June 2005
Handle: RePEc:nbr:nberwo:10402

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  1. Faust, Jon & Swanson, Eric T. & Wright, Jonathan H., 2004. "Identifying VARS based on high frequency futures data," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(6), pages 1107-1131, September.
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  3. d'Amico, Stefania & Mira Farka, 2003. "The Fed and Stock Market: A Proxy and Instrumental Variable Identification," Royal Economic Society Annual Conference 2003, Royal Economic Society 52, Royal Economic Society.
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  5. John Y. Campbell & John Ammer, 1991. "What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," NBER Working Papers 3760, National Bureau of Economic Research, Inc.
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  8. Goto, Shingo, 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, Anderson Graduate School of Management, UCLA qt04f1z5hb, Anderson Graduate School of Management, UCLA.
  9. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 246-73, April.
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  21. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports, Federal Reserve Bank of New York 99, Federal Reserve Bank of New York.
  22. Jeff Fuhrer & Geoff Tootell, 2004. "Eyes on the prize: how did the Fed respond to the stock market?," Public Policy Discussion Paper, Federal Reserve Bank of Boston 04-2, Federal Reserve Bank of Boston.
  23. John H. Boyd & Jian Hu & Ravi Jagannathan, 2005. "The Stock Market's Reaction to Unemployment News: Why Bad News Is Usually Good for Stocks," Journal of Finance, American Finance Association, American Finance Association, vol. 60(2), pages 649-672, 04.
  24. Demiralp, Selva & Jorda, Oscar, 2004. "The Response of Term Rates to Fed Announcements," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 36(3), pages 387-405, June.
  25. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
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