Show Me the Money: The Monetary Policy Risk Premium

91 Pages Posted: 27 Mar 2016 Last revised: 7 Oct 2018

See all articles by Ali K. Ozdagli

Ali K. Ozdagli

Federal Reserve Banks - Federal Reserve Bank of Boston

Mihail Velikov

Federal Reserve Bank of Richmond

Multiple version iconThere are 2 versions of this paper

Date Written: September 25, 2018

Abstract

We create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that previous studies link to how stocks react to monetary policy. Our index successfully captures stocks’ responses to both conventional and unconventional monetary policy. Stocks whose prices react more positively to expansionary monetary policy (high-MPE stocks) earn lower average returns. This result is consistent with the notion that high-MPE stocks provide a hedge against bad economic shocks, to which the Federal Reserve responds with expansionary monetary policy. A long-short trading strategy designed to exploit this effect achieves an annualized Sharpe Ratio of 0.77.

Keywords: Monetary Policy, Asset Pricing, Risk Factors

JEL Classification: E12, E31, E44, E52, G12, G14

Suggested Citation

Ozdagli, Ali K. and Velikov, Mihail, Show Me the Money: The Monetary Policy Risk Premium (September 25, 2018). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2754812 or http://dx.doi.org/10.2139/ssrn.2754812

Ali K. Ozdagli (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

HOME PAGE: http://sites.google.com/site/ozdagli/

Mihail Velikov

Federal Reserve Bank of Richmond ( email )

502 S. Sharp Street
Baltimore, MD 21201
United States

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