Abstract

This paper investigates the impact of monetary policy on stock returns in thirteen OECD
countries over the period 1972-2002. Our results indicate that monetary policy shifts significantly affect stock returns, thereby supporting the notion of monetary policy transmission via the stock market. Our contribution with respect to previous work is threefold. First, we show that our findings are robust to various alternative measures of stock returns. Second, our inferences are adjusted for the non-normality exhibited by the stock returns data. Finally, we take into account the increasing co-movement among international stock markets. The sensitivity analysis indicates that the results remain largely unchanged.
JEL classifications: E44; E52; E60

Keywords: Monetary policy; Asset prices

1. Introduction
Monetary policy attempts to achieve a set of objectives that are expressed in terms of
macroeconomic variables such as inflation, real output and employment. However, monetary
policy actions such as changes in the central bank discount rate have at best an indirect effect on these variables and considerable lags are involved in the policy transmission mechanism.
Broader financial markets though, for example the stock market, government and corporate
bond markets, mortgage markets, foreign exchange markets, are quick to incorporate new
information. Therefore, a more direct and immediate effect of changes in the monetary policy
instruments may be identified using financial data. Identifying the link between monetary
policy and financial asset prices is highly important to gain a better insight in the transmission 代写留学生论文 mechanism of monetary policy, since changes in asset prices play a key role in several channels.
In this paper, we provide empirical evidence on the relationship between monetary
policy and one of the most important financial markets, the stock market. Stock prices are
among the most closely monitored asset prices in the economy and are commonly regarded as
being highly sensitive to economic conditions. In the context of the transmission mechanism
through the stock market, monetary policy actions affect stock prices, which themselves are
linked to the real economy through their influence on consumption spending (wealth effect
channel) and investment spending (balance sheet channel)1. As Bernanke and Kuttner (2005)
point out, some observers view the stock market as an independent source of macroeconomic
volatility to which policymakers may wish to respond. Stock prices often exhibit pronounced
volatility and boom-bust cycles leading to concerns about sustained deviations from their
‘fundamental’ values that, once corrected, may have significant adverse consequences for the
broader economy. Hence, establishing quantitatively the existence of a stock market response
to monetary policy changes will not only be germane to the study of stock market
determinants but will also contribute to a deeper understanding of the conduct of monetary
policy and of the potential economic impact of policy actions or inactions.
According to the discounted cash flow model, stock prices are equal to the present
value of expected future net cash flows. Monetary policy should then play an important role
in determining equity returns either by altering the discount rate used by market participants<

BR>or by influencing market participants’ expectations of future economic activity. These
channels of influence are interlinked since more restrictive monetary policy usually implies
both higher discount rates and lower future cash flows. Thus, monetary policy tightening

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1 Goodhart and Hofmann (2000) establish empirically the link between output growth, credit aggregates, and
asset price movements in a number of major economies.

should be associated with lower stock prices given the higher discount rate for the expected
stream of cash flows and/or lower future economic activity. In contrast, an expansive
monetary environment is commonly viewed as good news as these periods are usually
associated with low interest rates, increases in economic activity and higher earnings for the
firms in the economy. Consequently, stock market participants pay close attention to
strategies based on the stance of the monetary authority as inferred by changes in indicators of
central bank policy. Also, the financial press often interprets asset price movements as
reaction to monetary policy shifts, attributing for instance increases in stock markets to low
interest rates.代写留学生论文
Previous empirical evidence broadly supports the notion that restrictive (expansive)
monetary policy decreases (increases) contemporaneous stock returns, as well as expected
stock returns2. These studies typically relate stock returns to measures of monetary policy
stringency in the context of single equation specifications and/or multivariate Vector
Autoregressions (VAR’s). In this paper we take a closer look at the impact of monetary policy
on stock returns by utilising thirty years of data across thirteen OECD countries. Given the
considerable debate on the relative merits of money aggregates during the late 1970s and
early 1980s, we adopt the nowadays standard approach of measuring monetary policy using
interest rate variables. We expand previous work by examining the sensitivity of our findings
to the inclusion of dividend payments in the stock returns calculation, while considering both
nominal and real returns. Our results indicate that for the majority of the countries under
investigation the monetary environment is an important determinant of investors’ required
returns. This holds across a variety of returns specifications (nominal, real, dividend adjusted,
non-adjusted). We also examine the contemporaneous effect of monetary policy on stock
returns taking into account the non-normality typically inherent in such data as well as the
significant co-movement of international stock markets. The main result, that expansionary
monetary policy boosts the stock market, remains largely robust in most sample countries.
The implications of such findings for monetary policy making and investor portfolio
formation are highly important. Central bankers and stock market participants should be
aware of the relationship between monetary policy and stock market performance in order to
better understand the effects of policy shifts. Monetary authorities in particular face the
dilemma of whether to react to stock price movements, above and beyond the standard
response to inflation and output developments. There is an ongoing debate in the m