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Understanding the Stock Market’s Response to Monetary Policy Shocks

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Abstract

This paper explores whether a limited participation model of the monetary transmission mechanism can account for the observed response of stock market returns to monetary policy shocks. It is found that the model generates responses that broadly match the empirical counterparts, although the magnitudes are somewhat too small. Moreover, the results suggest that the increased exposure of bank-dependent firms to liquidity shocks cannot fully account for the heterogenous responses of returns that are observed across firms.

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Paper provided by Oesterreichische Nationalbank (Austrian Central Bank) in its series Working Papers with number 93.

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Length: 32
Date of creation: 29 Dec 2004
Date of revision:
Handle: RePEc:onb:oenbwp:93

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Keywords: limited participation; asset pricing; stock market;

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References

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  1. Roberto Rigobon & Brian P. Sack, 2002. "The Impact of Monetary Policy on Asset Prices," NBER Working Papers 8794, National Bureau of Economic Research, Inc.
  2. Gertler, Mark & Gilchrist, Simon, 1994. "Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms," The Quarterly Journal of Economics, MIT Press, vol. 109(2), pages 309-40, May.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  4. Ben Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  5. Lastrapes, W. D., 1998. "International evidence on equity prices, interest rates and money," Journal of International Money and Finance, Elsevier, vol. 17(3), pages 377-406, June.
  6. Allan Timmermann & Gabriel Perez-Quiros, 1999. "Firm Size and Cyclical Variations in Stock Returns," FMG Discussion Papers dp335, Financial Markets Group.
  7. Giovannini, Alberto & Labadie, Pamela, 1991. "Asset Prices and Interest Rates in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1215-51, December.
  8. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  9. Marshall, David A, 1992. " Inflation and Asset Returns in a Monetary Economy," Journal of Finance, American Finance Association, vol. 47(4), pages 1315-42, September.
  10. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  11. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, vol. 52(2), pages 635-54, June.
  12. Anil Kashyap & Jeremy C. Stein, 1993. "Monetary Policy and Bank Lending," NBER Working Papers 4317, National Bureau of Economic Research, Inc.
  13. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  14. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  15. Kwanghee Nam & Thomas F. Cooley, 1998. "Asymmetric information, financial intermediation, and business cycles," Economic Theory, Springer, vol. 12(3), pages 599-620.
  16. Stephen G. Cecchetti, 1999. "Legal structure, financial structure, and the monetary policy transmission mechanism," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 9-28.
  17. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1.
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