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Monetary Policy and Mispricing in Stock Markets

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  • Beckers, Benjamin
  • Bernoth, Kerstin

Abstract

We investigate the role of monetary policy in stock price misalignments and explore whether central banks can attenuate excessive mispricing as suggested by the proponents of a “leaning against the wind” monetary policy. Decomposing stock prices into expected excess dividends, an equity risk premium, and a mispricing component, we find that prices fall more strongly in response to an increase in the policy rate than what is implied by their underlying fundamentals. This systematic overreaction suggests that tighter monetary policy may contain emerging asset price misalignments. Our findings are at odds with the predictions of a rational bubble framework, but can be explained by mispricing arising from false subjective expectations of irrational investors.

Suggested Citation

  • Beckers, Benjamin & Bernoth, Kerstin, 2023. "Monetary Policy and Mispricing in Stock Markets," MPRA Paper 120502, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:120502
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    Keywords

    Asset pricing; bubbles; leaning against the wind; mispricing; monetary policy; stock prices;
    All these keywords.

    JEL classification:

    • 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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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