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Stock Market Reaction to Fed Funds Rate Surprises: State Dependence and the Financial Crisis

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  • Kontonikas, Alexandros
  • MacDonald, Ronald
  • Saggu, Aman

Abstract

This paper examines the impact of Federal Funds rate (FFR) surprises on stock returns in the United States over the period 1989-2009, focusing on the impact of the recent financial crisis. We find that prior to the crisis, stock prices increased as a response to unexpected FFR cuts. State dependence is also identified with stocks exhibiting larger increases when interest rate easing coincided with recessions, bear stock markets, and tightening credit market conditions. However, an important structural shift took place during the financial crisis, which changed the stock market response to FFR shocks, as well as the nature of state dependence. Specifically, during the crisis period stock market participants did not react positively to unexpected FFR cuts. Our results highlight the severity of the recent financial turmoil episode and the ineffectiveness of conventional monetary policy close to the zero lower bound for nominal interest rates.

Suggested Citation

  • Kontonikas, Alexandros & MacDonald, Ronald & Saggu, Aman, 2012. "Stock Market Reaction to Fed Funds Rate Surprises: State Dependence and the Financial Crisis," SIRE Discussion Papers 2012-72, Scottish Institute for Research in Economics (SIRE).
  • Handle: RePEc:edn:sirdps:407
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    Keywords

    Monetary Policy; Stock Market; State Dependence; Financial Crisis;

    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
    • 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
    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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