Monetary Policy Expectation Skewness and Stock Market Returns

Abstract

This paper investigates the impact of monetary policy expectation skewness (SKEW) on asset pricing. Positive (negative) SKEW signals upside (downside) interest rate risk. We find that SKEW positively predicts stock market returns in the US, both in-sample and out-of-sample. Additionally, it generates considerable economic value for mean-variance investors. SKEW is associated with extreme investor beliefs about interest rate changes, and its predictive power primarily operates through a cash flow channel. Moreover, we show that SKEW outperforms realized interest rate outcomes and interest rate expectations in predicting stock market returns.

Keywords: Monetary Policy Expectation; Interest Rate Skewness; Return Predictability; Investor Belief

JEL Classification: E4, G15