Working Paper: NBER ID: w8794
Authors: Roberto Rigobon; Brian Sack
Abstract: Estimating the response of asset prices to changes in monetary policy is complicated by the endogeneity of policy decisions and the fact that both interest rates and asset prices react to numerous other variables. This paper develops a new estimator that is based on the heteroskedasticity that exists in high frequency data. We show that the response of asset prices to changes in monetary policy can be identified based on the increase in the variance of policy shocks that occurs on days of FOMC meetings and of the Chairman's semi-annual monetary policy testimony to Congress. The identification approach employed requires a much weaker set of assumptions than needed under the 'event-study' approach that is typically used in this context. The results indicate that an increase in short-term interest rates results in a decline in stock prices and in an upward shift in the yield curve that becomes smaller at longer maturities. The findings also suggest that the event-study estimates contain biases that make the estimated effects on stock prices appear too small and those on Treasury yields too large.
Keywords: No keywords provided
JEL Codes: E44; E47; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short-term interest rates (E43) | stock prices (G12) |
| short-term interest rates (E43) | other asset prices (G19) |
| other asset prices (G19) | stock prices (G12) |
| monetary policy shocks (E39) | asset prices (G19) |