Stock Market's Assessment of Monetary Policy Transmission: The Cash Flow Effect

56 Pages Posted: 7 Oct 2019

See all articles by Refet S. Gürkaynak

Refet S. Gürkaynak

Bilkent University - Department of Economics

Sang Seok Lee

Bilkent University

Gokce Karasoy Can

Central Bank of Turkey

Multiple version iconThere are 3 versions of this paper

Date Written: September 2019

Abstract

We show that firm liability structure and associated cash flow matter for firm behavior, and that financial market participants price stocks accordingly. Looking at firm level stock price changes around monetary policy announcements, we find that firms that have more cash flow exposure see their stock prices affected more. The stock price reaction depends on the maturity and type of debt issued by the firm, and the forward guidance provided by the Fed. This effect has remained intact during the ZLB period. Importantly, we show that the effect is not a rule of thumb behavior outcome and that the marginal stock market participant actually studies and reacts to the liability structure of firm balance sheets. The cash flow exposure at the time of monetary policy actions predicts future net worth, investment, and assets, verifying the stock pricing decision and also providing evidence of cash flow effects on firms' real behavior. The results hold for S&P500 firms that are usually thought of not being subject to tight financial constraints.

Keywords: Cash flow effect of monetary policy, Financial Frictions, Investor sophistication, stock pricing

JEL Classification: E43, E44, E52, E58, G14

Suggested Citation

Gürkaynak, Refet S. and Lee, Sang Seok and Karasoy Can, Gokce, Stock Market's Assessment of Monetary Policy Transmission: The Cash Flow Effect (September 2019). CEPR Discussion Paper No. DP14017, Available at SSRN: https://ssrn.com/abstract=3464546

Refet S. Gürkaynak (Contact Author)

Bilkent University - Department of Economics ( email )

06533 Ankara
Turkey

Sang Seok Lee

Bilkent University ( email )

Bilkent, 06533
Turkey

Gokce Karasoy Can

Central Bank of Turkey ( email )

Ankara
Turkey

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