Asset Returns, Discount Rate Changes, and Market Efficiency

Abstract

Considerable empirical evidence has been presented (e.g., Waud (1970)) to support the assertion that discount rate changes contain "announcement effects" concerning the future course of monetary policy which significantly affect security prices.1 Roley and Troll (1984) contend that the validity of this assertion depends on the operating procedures employed by the monetary authorities, Specifically, they present an analytical framework which demonstrates that with a policy of interest rate targeting, which characterized open market operating procedures prior to October 1979 (pre-79), no meaningful announcement effects are possible since any effects on nrket rates would be offset by changes in the level of nonborrowed reserves. Under nonborrowed reserve targeting, which has characterized post-October 1979 (post-79) monetary policy, changes in discount rates affect interest rates directly via (at least) changes in the expected short-run money path. Consistent with this view, Roley and Troll report no nnonco ffe&-c from discount rate changes on the term structure of interest rates from

The Fed and short-term rates: Is it open market operations, open mouth operations or interest rate smoothing?

“…16 Announcement effects are common. Market rates have, at various times and under various circumstances, responded significantly to a variety of news: money surprises (e.g., Hardouvelis (1987) and Thornton (1989)), changes in the discount rate (e.g., Thornton (1994Thornton ( , 1998Thornton ( , 2000b, Roley and Troll (1984), Smirlock and Yawitz (1985), Cook and Hahn (1988), Batten andThornton (1984, 1985)), the employment report (e.g., Hardouvelis (1987) and Cook and Korn (1991)) and other special announcements (Cook and Hahn (1988)). What is often not known, and is difficult to determine, is precisely why markets react to this information, e.g., Thornton (1998).…”

Monetary policy, exchange rates and stock prices in the Middle East region

“…4 Starting from the dividend discount model for stock valuation, monetary policy which a ects market interest rates is predicted to a ect stock prices through two main channels (Smirlock and Yawitz (1985)). First a contractionary monetary policy which may be conducted through increasing policy rates, will eventually lead to a rise in the market interest rates that are used by investors to discount expected future cash ows resulting in lower stock prices.…”

Monetary policy and stock valuation: structural VAR identification and size effects

“…1 The empirical literature investigating the relationship between monetary policy and stock valuation in the United States goes back to 1970s. 2 In these early studies it is acknowledged that causality may run in both directions (Cooper, 1974;Smirlock and Yawitz, 1985). Given that stock prices, amongst other asset prices, feature in the monetary policy transmission mechanism, it is important to gain a thorough understanding of how monetary policy interacts with stock market developments (Mishkin, 2001;Bjornland and Jacobsen, 2013).…”

“…Monetary policy may affect stock prices through its impact on the expected future net cash flows and the discount rate; the latter being equal to the sum of a risk-free interest rate and a risk premium (Smirlock and Yawitz, 1985;Kontonikas and Kostakis, 2013). According to the traditional interest rate channel, monetary policy tightening lowers the demand for loans due to higher costs of borrowing.…”

“…This paper re-examines this relationship at both the market and portfolio level using data on portfolios formed on the basis of firm's size (market value). The empirical framework that we use allows for the short-run interaction between monetary policy and real stock price developments, assuming long-run monetary neutrality.Monetary policy may affect stock prices through its impact on the expected future net cash flows and the discount rate; the latter being equal to the sum of a risk-free interest rate and a risk premium (Smirlock and Yawitz, 1985; Kontonikas and Kostakis, 2013). According to the traditional interest rate channel, monetary policy tightening lowers the demand for loans due to higher costs of borrowing.…”