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Stock prices, firm size, and changes in the federal funds rate target

  • Hui Guo
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The Fed targeted the federal funds rate during the period 1974-79; they returned to that procedure in the late 1980s and have maintained it since then. For both periods, we find that stock prices reacted significantly to unanticipated changes in the federal funds rate target, but not to anticipated ones. Consistent with the prediction of imperfect capital market theories, the estimated impact of monetary shocks is significantly larger for small stocks than for big stocks in the late 1970s, when business conditions were typically bad. However, the "size effect" is not present in the 1990s, when business conditions were typically good. We document a similar pattern using portfolios formed according to the book-to-market value ratio. Our evidence of the state-dependent monetary effect provides support for recent rationales about the anomalous size and value premiums.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2002-004.

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Date of creation: 2003
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Publication status: Published in Quarterly Review of Economics & Finance, September 2004, 44(4), pp. 487-507
Handle: RePEc:fip:fedlwp:2002-004
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