Monetary Policy Uncertainty and the Stock Market

48 Pages Posted: 13 Apr 2005

Date Written: January 2005


We study the relationship between inflation and stock returns focusing on the signalling content of inflation. Investors use inflation to learn about the stance of the monetary policy. Depending on investors' beliefs, a change in consumption prices has different effects on the risk premium. A change in consumption prices that confirms investors' beliefs reduces stock risk premia, while a change that contradicts them increases risk premia. This may generate a negative correlation between returns and inflation that explains the Fisher puzzle. We model this intuition and test its implication on US data. We construct a market-based proxy of monetary policy uncertainty, we show that it is priced and that, by conditioning on it, the Fisher puzzle disappears.

Keywords: Monetary policy uncertainty, asset pricing, learning risk, risk factors

JEL Classification: G11, G12, G14

Suggested Citation

Massa, Massimo and Locarno, Alberto, Monetary Policy Uncertainty and the Stock Market (January 2005). CEPR Discussion Paper No. 4828. Available at SSRN:

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

Alberto Locarno (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184

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