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Monetary Policy Effects on Long-term Rates and Stock Prices

  • Ranaldo, Angelo

    ()

  • Reynard, Samuel

    ()

This paper explains the effects of monetary policy surprises on long-term interest rates and stock prices in terms of changes in expected inflation, real interest rate and dividend growth, and relates these effects to markets’ perceptions of economic shocks and Fed’s information set. We analyze stock and bond futures price co-movements and relate them to Treasury Inflation-Protected Securities (TIPS) data. The sign of long-term interest rate reactions is mostly driven by changes in expected inflation. The sign of stock price reactions is mostly driven by changes in expected dividend growth, but it is also sometimes determined by changes in expected real rates. The co-movements of long-term interest rates and stock prices are determined by the co-movements of expected inflation and dividend growth. The majority of Fed’s interest rate surprises are expected to be followed by negative co-movements between inflation and output. This can be due to relatively more frequent “inflation” or “supply” shocks together with Fed’s private information. Most Fed’s actions are perceived as reactions to economic shocks rather than true policy shocks.

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File URL: http://www1.vwa.unisg.ch/RePEc/usg/sfwpfi/WPF-1322.pdf
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Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1322.

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Length: 35 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:usg:sfwpfi:2013:22
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Web page: http://www.unisg.ch/de/Schools/Finance.aspx

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  1. Campbell, J.Y. & Ammer, J., 1991. "What Moves The Stock And Bond Markets? A Variance Decomposition For Long- Term Asset Returns," Papers 127, Princeton, Department of Economics - Financial Research Center.
  2. Ben S. Bernanke & Kenneth N. Kuttner, 2004. "What explains the stock market's reaction to Federal Reserve policy?," Finance and Economics Discussion Series 2004-16, Board of Governors of the Federal Reserve System (U.S.).
  3. Demiralp, Selva & Jorda, Oscar, 2004. "The Response of Term Rates to Fed Announcements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 387-405, June.
  4. Refet Gürkaynak & Brian Sack, 2005. "Do Actions Speak Louder Than Words?The Response of Asset Prices to Monetary Policy Actions and Statements," Computing in Economics and Finance 2005 323, Society for Computational Economics.
  5. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  6. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  7. Tore Ellingsen & Ulf Soderstrom, 2001. "Monetary Policy and Market Interest Rates," American Economic Review, American Economic Association, vol. 91(5), pages 1594-1607, December.
  8. David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
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