Monetary rules, monetary shocks and stock prices

Abstract

The present work consists of two empirical studies on monetary and nancial economics. First study employs a generalized ordered probit method to model the Federal Reserve's monetary policy reaction function. The findings indicate that the Fed takes into account not only inflation and output gap measures but also several other variables during its decision process, but the degree of its attention on each variable is choice-dependent. The threshold estimates also indicate that the Federal Reserve acts asymmetrically that it waits for relatively significant changes in the macroeconomic factors before it decides for a change in its target rates. However, once these thresholds are passed, relatively less significant changes in the economy are needed for the Federal Reserve to take action. Second study investigates the relationship between inflation and stock returns using industry-level stock returns data. I propose using VARs with block exogeneity, and diag- onality restrictions to use many variables in the model and infinite-horizon restrictions to identify aggregate shocks, i.e. money supply and productivity. The results show that the relation between in ation and stock returns depends on both the type of macro shock and industry. The relation is negative given a productivity shock, yet positive given a money supply shock. The ndings also suggest that size and book-to-market ratio affect dispersion of industry portfolio returns given a macroeconomic shock.