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Stock market reaction to fed funds rate surprises: state dependence and the financial crisis

Listed author(s):
  • Alexandros Kontonikas
  • Ronald MacDonald
  • Aman Saggu

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.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2012_11.

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Date of creation: Sep 2012
Handle: RePEc:gla:glaewp:2012_11
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