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Monetary Policy, External Finance Dependence, and the Cross-section of Stock Returns: A FAVAR Approach

  • Victor Duarte

    (MIT)

  • Carlos Carvalho

    (Pontificia Universidade Catolica do Rio de Janeiro)

  • Tiago Berriel

    (EPGE-FGV)

We use an identified factor-augmented vector autoregression (FAVAR) to estimate the impact of monetary policy shocks on the cross-section of stock returns. Our FAVAR combines unobserved factors extracted from a large set of financial and macroeconomic indicators with the Federal Funds rate. We find that monetary policy shocks have heterogeneous effects on the cross-section of stock returns. These effects are well explained by the degree of external finance dependence, and by variables that arguably correlate with it. We also find that the cross- section of stock return responses to monetary policy shocks can be very well explained by the response of the Fama-French factors to those shocks.

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File URL: https://www.economicdynamics.org/meetpapers/2013/paper_1214.pdf
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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 1214.

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Date of creation: 2013
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Handle: RePEc:red:sed013:1214
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  1. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
  2. Ben Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Raghuram G. Rajan & Luigi Zingales, . "Financial Dependence and Growth," CRSP working papers 344, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  4. Boivin, Jean & Giannoni, Marc P. & Mihov, Ilian, 2006. "Sticky prices and monetary policy: Evidence from disaggregated US data," CFS Working Paper Series 2007/14, Center for Financial Studies (CFS).
  5. Willem Thorbecke, 1995. "On Stock Market Returns and Monetary Policy," Economics Working Paper Archive wp_139, Levy Economics Institute.
  6. Stock J.H. & Watson M.W., 2002. "Forecasting Using Principal Components From a Large Number of Predictors," Journal of the American Statistical Association, American Statistical Association, vol. 97, pages 1167-1179, December.
  7. Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," STICERD - Theoretical Economics Paper Series /1997/321, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
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