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Monetary Policy, External Finance Dependence, and the Cross-section of Stock Returns: A FAVAR Approach

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  • Victor Duarte

    (MIT)

  • Carlos Carvalho

    (Pontificia Universidade Catolica do Rio de Janeiro)

  • Tiago Berriel

    (EPGE-FGV)

Abstract

We use an identified factor-augmented vector autoregression (FAVAR) to estimate the impact of monetary policy shocks on the cross-section of stock returns. Our FAVAR combines unobserved factors extracted from a large set of financial and macroeconomic indicators with the Federal Funds rate. We find that monetary policy shocks have heterogeneous effects on the cross-section of stock returns. These effects are well explained by the degree of external finance dependence, and by variables that arguably correlate with it. We also find that the cross- section of stock return responses to monetary policy shocks can be very well explained by the response of the Fama-French factors to those shocks.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 1214.

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Date of creation: 2013
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Handle: RePEc:red:sed013:1214

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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  1. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, 06.
  2. Boivin, Jean & Giannoni, Marc & Mihov, Ilian, 2007. "Sticky Prices and Monetary Policy: Evidence from Disaggregated US Data," CEPR Discussion Papers 6101, C.E.P.R. Discussion Papers.
  3. Ben S. Bernanke & Alan S. Blinder, 1989. "The federal funds rate and the channels of monetary transmission," Working Papers 89-10, Federal Reserve Bank of Philadelphia.
  4. Raghuram G. Rajan & Luigi Zingales, 1996. "Financial Dependence and Growth," NBER Working Papers 5758, National Bureau of Economic Research, Inc.
  5. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, vol. 52(2), pages 635-54, June.
  6. Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," NBER Working Papers 5907, National Bureau of Economic Research, Inc.
  7. Stock J.H. & Watson M.W., 2002. "Forecasting Using Principal Components From a Large Number of Predictors," Journal of the American Statistical Association, American Statistical Association, vol. 97, pages 1167-1179, December.
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