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The stock market and the Fed

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The paper investigates the reaction of the Federal Reserve to developments in the stock market. The issue is analyzed by first constructing an Index of Stock Price Misalignement in which the fundamental value of the stocks is computed on the basis of the discounted cash flow approach and by then including this index, among the regressors, into a forward looking Taylor rule. In accordance with the descriptive evidence, based mainly on the analysis of the FOMC meetings and public statements, our findings show that the Fed tends to lower the Fed funds rate when stock prices fall below their fundamental value, while there is no evidence of monetary stringency during episodes of exuberance in the stock market.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 113.

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Length: 31 pages
Date of creation: 14 Jul 2008
Date of revision: 14 Jul 2008
Handle: RePEc:rtv:ceisrp:113

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Web page: http://www.ceistorvergata.it
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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Web: http://www.ceistorvergata.it

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  1. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
  2. Steven N. Kaplan & Richard S. Ruback, 1994. "The Valuation of Cash Flow Forecasts: An Empirical Analysis," NBER Working Papers 4724, National Bureau of Economic Research, Inc.
  3. Edward Nelson, 2000. "UK monetary policy 1972-97: a guide using Taylor rules," Bank of England working papers 120, Bank of England.
  4. Samy Ben Naceur & Mohamed Goaied, 2004. "The value relevance of accounting and financial information: panel data evidence," Applied Financial Economics, Taylor & Francis Journals, vol. 14(17), pages 1219-1224.
  5. repec:rtv:ceiswp:211 is not listed on IDEAS
  6. Michele Bagella & Leonardo Becchetti & Rocco Ciciretti, 2007. "Market vs. analysts reaction: the effect of aggregate and firm-specific news," Applied Financial Economics, Taylor & Francis Journals, vol. 17(4), pages 299-312.
  7. Charles M. C. Lee & James Myers & Bhaskaran Swaminathan, 1999. "What is the Intrinsic Value of the Dow?," Journal of Finance, American Finance Association, vol. 54(5), pages 1693-1741, October.
  8. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  9. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
  10. James Claus, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, vol. 56(5), pages 1629-1666, October.
  11. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06.
  12. Leonardo Becchetti & Fabrizio Adriani, 2004. "Do high-tech stock prices revert to their 'fundamental' value?," Applied Financial Economics, Taylor & Francis Journals, vol. 14(7), pages 461-476.
  13. Sunil Mohanty & Edward Aw, 2006. "Rationality of analysts' earnings forecasts: evidence from dow 30 companies," Applied Financial Economics, Taylor & Francis Journals, vol. 16(12), pages 915-929.
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