Monetary Policy Surprises, Investment Opportunities, and Asset Prices
50 Pages Posted: 11 Jan 2015 Last revised: 9 Apr 2017
Date Written: April 1, 2017
Recent evidence shows that monetary policy announcements convey significant information about expected market returns and are therefore good candidates for innovations in intertemporal-asset pricing state variables. I propose an asset pricing model with the market return and a mimicking portfolio for unexpected changes in the federal funds rate on days of FOMC announcements. This economically motivated two-factor model prices portfolios formed on size, value, momentum, investment, and profitability with an R2 of 80% and an average annual pricing error of 0.93%-performing as well as standard four-, five- and six-factor models designed to price these assets.
Keywords: Monetary Policy, Cross-section of Stock Returns, ICAPM
JEL Classification: E44, G12
Suggested Citation: Suggested Citation