The Fed and the Stock Market: A Tale of Sentiment States

75 Pages Posted: 23 Jun 2018 Last revised: 16 Jun 2019

See all articles by Haifeng Guo

Haifeng Guo

Durham University Business School

Chi-Hsiou Daniel Hung

University of Glasgow - Adam Smith Business School

Alexandros Kontonikas

Essex Business School

Date Written: June 14, 2019

Abstract

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

Guo, Haifeng and Hung, Chi-Hsiou Daniel and Kontonikas, Alexandros, The Fed and the Stock Market: A Tale of Sentiment States (June 14, 2019). Available at SSRN: https://ssrn.com/abstract=3184974 or http://dx.doi.org/10.2139/ssrn.3184974

Haifeng Guo

Durham University Business School ( email )

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

Chi-Hsiou Daniel Hung

University of Glasgow - Adam Smith Business School ( email )

Gilbert Scott Building
University of Glasgow
Glasgow, Scotland G12 8QQ
United Kingdom

Alexandros Kontonikas (Contact Author)

Essex Business School ( email )

University of Essex
Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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