What Determines the Stock Market's Reaction to Monetary Statements

Review of Financial Economics 21 (2012) 175–187

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What determines the stock market 's reaction to monetary policy statements?☆
Alexander Kurov ⁎
College of Business and Economics, West Virginia University, Morgantown, WV 26506, USA

article

info

Article history:
Received 5 October 2011
Received in revised form 30 May 2012
Accepted 26 June 2012
Available online 4 July 2012
JEL classification:
E44
E52
E58
G14

abstract
We find that information communicated through monetary policy statements has important business cycle dependent implications for stock prices. For example, during periods of economic expansion, stocks tend to respond negatively to announcements of higher rates ahead. In recessions, however, we find a strong positive reaction of stocks to seemingly similar signals of future monetary tightening. We provide evidence that the state dependence in the stock market 's response is explained by information about the expected equity premium and future corporate cash flows contained in monetary policy statements. We also show state dependence in the average stock returns on days of scheduled FOMC meetings and in the impact of monetary policy statements on stock and bond return volatility.
© 2012 Elsevier Inc. All rights reserved.

Keywords:
Monetary policy
FOMC statements
Stock market
Business cycle

1. Introduction
At a media dinner in April 2006, the Fed Chairman Ben Bernanke told CNBC reporter Maria Bartiromo that investors underestimated his willingness to use monetary policy to fight inflation. Immediately after Ms. Bartiromo reported it on her program, the S&P 500 index dropped by about 0.8% and Treasury bond yields jumped to four-year highs. Investors interpreted Mr. Bernanke 's remark as a sign that the
Fed may continue its interest-rate boosting campaign longer than previously

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