Central bank independence and stock price crash risk

When a central bank lacks independence and is subject to political influence, pressure to lower interest rates intensifies. Consequently, markets come to expect rate cuts or a slower pace of increases. These sticky expectations can trigger stock price crash risk when rates rise. We develop a simple model in which investors respond asymmetrically to interest rate signals and show that this asymmetry is amplified by biased investors. Evidence from 22 non-Eurozone countries supports this prediction. When the policy rate increases, countries with low central bank independence (CBI) exhibit larger, more positive monetary policy surprises than high CBI countries, implying biased beliefs under low CBI. Stock markets are more overvalued in low CBI countries than in high CBI countries, and this overvaluation is sensitive to policy rate hikes. In low CBI countries, rate hikes result in pronounced return declines and elevated crash risk, whereas high CBI countries exhibit no such pattern.