The Fed and the Stock Market: A Tale of Sentiment States
75 Pages Posted: 23 Jun 2018 Last revised: 16 Jun 2019
Date Written: June 14, 2019
We show that the state of investor sentiment strongly affects the transmission of monetary policy to the stock market. Before the zero lower bound (ZLB), the impact of Federal funds rate (FFR) surprises is mostly potent when sentiment-driven overvaluation is followed by a correction, whereby the stock market increases by 0.8% in response to an unexpected FFR cut of 10 basis points. Monetary easing surprises boost the stock market by alleviating investors’ fear and consequently, increasing their willingness to bear risk. At the ZLB, we find a significant effect from Large Scale Asset Purchases only during periods of decreasing sentiment.
Keywords: Investor Sentiment, Monetary Policy Surprises, Event Study
JEL Classification: E52, G12, G14
Suggested Citation: Suggested Citation