Monetary Policy and Mispricing in Stock Markets

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Abstract This paper investigates whether central banks can attenuate excessive mispricing in stocks as suggested by the proponents of a "leaning against the wind" (LATW) monetary policy. For this, we decompose stock prices into a fundamental component, a risk premium, and a mispricing component. We argue that mispricing can arise for two reasons: (i) from false subjective expectations of investors about future fundamentals and equity premia; and (ii) from the inherent indeterminacy in asset pricing in line with rational bubbles. We show that the response of the excessive stock price component to a monetary policy shock is ambiguous in both the short-and long-run, and depends on the nature of the mispricing. Subsequently, we evaluate the scope for a LATW policy empirically by employing a time-varying coefficient VAR with a flexible identification scheme based on impact and long-run restrictions using data for the S&P500 index from 1962Q1 to 2014Q4. We find that a contractionary monetary policy shock in fact lowers stock prices beyond what is implied by the response of their underlying fundamentals. Terms of use: Documents in

To Lean or Not to Lean Against an Asset Price Bubble? Empirical Evidence

“…Specifically, there is a strong decline in the first 10 months after an increase in the FFR, followed by a gradual increase of the bubble term which tends towards zero in the long term. Our findings are in line with conventional wisdom and closely related studies (Allen, Barlevy, and Gale 2017; Beckers and Bernoth 2016; Dudley 2010; Mishkin 2008, 2010) who advocate that raising rates dampens bubbles rather than amplifying them and contrast with the view of Galí (2014) and Galí and Gambetti (2015) who support that the size of the bubble increases persistently in response to a tightening monetary policy.…”

“…On the other hand, we allow the fundamental component to decrease on impact while the bubble component is also allowed to respond, yet the sign of the response is left unrestricted. The imposed sign on the fundamental component is motivated by the economic theory (see Beckers and Bernoth 2016) which predicts a decrease of the fundamental component of share prices in response to a contractionary monetary policy shock, since the latter decreases future economic growth and thus firms' profitability and future dividend payouts. Note that an opposing effect may appear if market participants are less informed about the future path of output and inflation than the policymakers.…”

“…Second, Beckers and Bernoth (2016) also challenge the theoretical predictions of Galí by generalizing the concept of rational bubbles to a broader idea of asset mispricing. They also reassess the empirical findings of Galí and Gambetti (2015) by employing a less restrictive econometric strategy to identify monetary policy shocks and conclude that monetary policy tightening lowers stock prices significantly.…”

Less Bang for the Buck? Assessing the Role of Inflation Uncertainty for U.S. Monetary Policy Transmission in a Data Rich Environment

“…The main advantage is that this identification framework seems particularly suited in the light of ample evidence for contemporaneous simultaneity between monetary policy and financial variables (see, e.g. Björnland and Leitemo, 2009;Lütkepohl and Netšunajev, 2014;Beckers and Bernoth, 2016). A recursive setting in the vein of Bernanke et al (2005) prevents any instantaneous reaction of monetary policy makers to high-frequency information contained in financial indicators, such as stock prices and bond yields.…”

“…In addition, it enables us to deal with a variety of complementary sources of regime dependence and carve out more precise policy implications. Third, we refrain from imposing recursiveness and adopt a sign restriction approach (Faust, 1998;Uhlig, 2005) to identify of the monetary policy shock and characterize the interdependence between monetary policy, asset prices and other financial indicators (see, e.g., Björnland and Leitemo, 2009;Lütkepohl and Netšunajev, 2014;Beckers and Bernoth, 2016).…”