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Brown Bag - How does the equity premium respond to monetary policy, and why?

Tim Kröncke, University of Basel

His paper presents new evidence on the channels through which monetary policy affects the equity premium. We find that  -- contrary to conventional wisdom -- monetary policy's impact on the yield curve via expectation and term premium channels plays almost no role as driver of changes in the equity premium around FOMC meetings. Instead, virtually all of the U.S. equity market price moves can be attributed to shocks that are closely linked investor risk appetite, but orthogonal to yield changes. These price effects are mirrored by investors' portfolio rebalancing decisions, manifesting themselves via sizeable shifts in ETF flows between bonds and equities. A monetary policy shock that raises risk appetite is associated with higher equity prices relative to bonds and a significant reallocation shift from bonds to equities and other risky assets.

Dept. of Finance