Does Monetary Policy Affect Stock Prices and Treasury Yields? An Error Correction and Simultaneous Equation Approach
32 Pages Posted: 27 May 2003
Date Written: March 2003
This study pursues two addenda to the practitioner and academic literature on the effect of monetary policy on asset prices. First, this paper applies cointegration theory and, second, relaxes the stringent assumption in the literature that changes in 10-year Treasury yields, stock returns, and changes in the stance of monetary policy are exogenous. Given quarterly data from 1978:Q4 to 2002:Q3, two-stage least squares (2SLS) regressions suggest that changes in the exogenous component of the federal funds rate affect changes in Treasury yields but not stock returns, ceteris paribus. However, this result is sensitive to alternative proxies for the stance of monetary policy. Also, little evidence suggests that monetary policy responds to the exogenous components of changes in financial asset prices.
Keywords: Monetary policy, asset pricing, stock returns, bond yields
JEL Classification: E52, G14
Suggested Citation: Suggested Citation