The Response of Asset Prices to Monetary Policy Shocks: Stronger than Thought

49 Pages Posted: 19 Oct 2016

See all articles by Lucia Alessi

Lucia Alessi

European Central Bank (ECB)

Mark Kerssenfischer

Deutsche Bundesbank

Date Written: September 30, 2016

Abstract

Mainstream macroeconomic theory predicts a rapid response of asset prices to monetary policy shocks, which conventional empirical models are unable to reproduce. We argue that this is due to a deficient information set: Forward-looking economic agents observe vastly more information than the handful of variables included in standard VAR models. Thus, small-scale VARs are likely to suffer from nonfundamentalness and yield biased results. We tackle this problem by estimating a Structural Factor Model for a large euro area dataset. We find quicker and larger effects of monetary policy shocks, consistent with mainstream theory and the observed large swings in asset prices. Our results point to stronger financial stability consequences of an exogenous monetary policy tightening, also in the form of a quicker than expected unwinding of QE, than commonly thought.

Keywords: Asset Prices, Monetary Policy, Structural Factor Models, Nonfundamentalness

JEL Classification: C32, E43, E44, E52

Suggested Citation

Alessi, Lucia and Kerssenfischer, Mark, The Response of Asset Prices to Monetary Policy Shocks: Stronger than Thought (September 30, 2016). ECB Working Paper No. 1967. Available at SSRN: https://ssrn.com/abstract=2854133

Lucia Alessi (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Mark Kerssenfischer

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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