Monetary Policy and the Cross-Section of Stock Returns in a Market with Distortions

Abstract

We study the effects of monetary policy in an economy with distortions. Between 2006 and 2019, China’s central bank frequently adjusted required reserve ratios (RR) and interest rates (IR) to implement monetary policy. We examine how stock prices react to these adjustments and distinguish between state-owned-enterprises (SOEs) and private-owned-enterprises (POEs). We find that SOEs benefit disproportionately more from expansionary monetary policy than POEs, especially via interest rate cuts. In contrast, POEs benefit greatly from contractionary monetary policy via interest rate hikes. These findings shed light on the monetary transmission mechanisms in a market with interest rate control and credit rationing.

Keywords: monetary policy, cross-section of stock returns, state-owned enterprises

JEL Classification: E58, G14, G30, P34