Monetary Policy and the Investment Companies
41 Pages Posted: 1 Nov 2018
Date Written: 2018
We examine the impact of monetary policy actions on the returns of investment companies. We observe that an expansionary monetary policy action increases the returns of investment companies, while a contractionary policy action depresses the returns. We observe that monetary policy actions have asymmetric effects on returns across different monetary policy environments. We observe that the response of the returns of investment companies to surprise federal funds target rate changes is large and statistically significant. Returns are statistically significantly affected by positive policy surprises (larger than expected value of the federal funds target rate) while they are not significantly affected by negative positive surprises. We observe that the effects of monetary policy on the investments companies are asymmetric across different business conditions and the results are robust to different identification schemes of the business conditions. We find evidence that the effect of monetary policy on the returns of investments companies in good business conditions is statistically significant compared to bad business conditions. Surprise monetary expansion is interpreted by investors as bad news in high levels of economic activity while it is interpreted as good news in low levels of economic activity. Furthermore, we find that the asymmetric effect of monetary policy across different business conditions are due to the asymmetric effect of monetary policy on the discount rates and expected cash flow proxies. Moreover, we find evidence that the effect of monetary policy on the returns of investments companies are driven by its effect through changes in discount rate proxies as opposed to expected cash flow proxies. The results imply that the monetary policy plays a strong signaling role for the stock market and that any asset-pricing model for investments companies should take into account the effect of monetary policy by incorporating an interest rate-based indicator of monetary policy in the model.
Keywords: Monetary Policy, Investments companies, Business Conditions, Stock Returns
JEL Classification: E52, G20
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