Monetary Policy and Stock Prices: Does the 'Fed Put' Work When It Is Most Needed?

Abstract

Most studies of the effect of monetary policy on asset prices use the event study methodology with daily data. The resulting estimates suffer from bias due to omitted variables and endogeneity of policy decisions. We provide evidence that this bias becomes so large during the 2007-2008 financial crisis that it reverses the sign of the estimated stock market response to monetary news, leading to an erroneous conclusion that interest rate cuts are bad news for stocks. We also examine the stock market reaction to monetary policy during the zero lower bound period. The results show a significant bias in daily event study estimates of the stock market response to news about the future path of monetary policy.

Keywords: Monetary policy, Stock returns, Intraday data, Financial crisis

JEL Classification: E44, E52, E58, G14, G18