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The response of asset prices to monetary policy shocks: stronger than thought

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  • Alessi, Lucia
  • Kerssenfischer, Mark

Abstract

Mainstream macroeconomic theory predicts a rapid response of asset prices to monetary policy shocks, which conventional empirical models are unable to reproduce. We argue that this is due to a deficient information set: Forward-looking economic agents observe vastly more information than the handful of variables included in standard VAR models. Thus, small-scale VARs are likely to suffer from nonfundamentalness and yield biased results. We tackle this problem by estimating a Structural Factor Model for a large euro area dataset. We find quicker and larger effects of monetary policy shocks, consistent with mainstream theory and the observed large swings in asset prices. Our results point to stronger financial stability consequences of an exogenous monetary policy tightening, also in the form of a quicker than expected unwinding of QE, than commonly thought. JEL Classification: C32, E43, E44, E52

Suggested Citation

  • Alessi, Lucia & Kerssenfischer, Mark, 2016. "The response of asset prices to monetary policy shocks: stronger than thought," Working Paper Series 1967, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20161967
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    Cited by:

    1. Kerssenfischer, Mark, 2017. "The effects of US monetary policy shocks: Applying external instrument identification to a dynamic factor model," Discussion Papers 08/2017, Deutsche Bundesbank.
    2. Helmut Lütkepohl & Aleksei Netšunajev, 2018. "The Relation between Monetary Policy and the Stock Market in Europe," Econometrics, MDPI, Open Access Journal, vol. 6(3), pages 1-14, August.
    3. Amat Adarov, 2017. "Financial Cycles in Credit, Housing and Capital Markets: Evidence from Systemic Economies," wiiw Working Papers 140, The Vienna Institute for International Economic Studies, wiiw.

    More about this item

    Keywords

    Asset Prices; monetary policy; Nonfundamentalness.; Structural Factor Models;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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

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