Reaction of Stock Market to Monetary Policy Surprises

Wiranto, Wellian. 2008. Reaction of Stock Market to Monetary Policy Surprises. Doctoral Dissertation, Cornell University.

This paper provides an empirical analysis of stock market reactions to monetary policy surprises. Its principal objective is to understand the heterogeneous nature of this type of response by examining a set of possible explanatory factors. I find that a hypothetical unanticipated increase of 25 bps in the target Federal Reserve funds rate would result in a one-day decline of 1.3 percent in the prices of S&P 500 stocks. There is some evidence that factors such as sector and industry groups, firm size, and the foreign earnings exposure of a firm could affect the reaction reflected in its stock price. The severity of the equity market’s response also appears to be associated with elements of the macroeconomic environment such as the level of prevailing interest rates and inflation expectations. Moreover, my results suggest that a lack of unanimity in the FOMC votes could curb the reaction of the stock market.

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Three Essays On Monetary Policy In Economies With Financial Frictions

Anand, Rahul. 2010. Three Essays On Monetary Policy In Economies With Financial Frictions. Doctoral Dissertation, Cornell University.

The objective of this dissertation is to understand the role of financial frictions in the transmission of shocks and their effect on the monetary policy transmission mechanism. To accomplish the task, we develop Dynamic Stochastic General equilibrium models with financial frictions. In the first chapter, we develop a model to analytically determine the appropriate price index to target in the presence of financial frictions (where a fraction of households are constrained to consume their wage income each period). The analysis suggests that in the presence of financial frictions, a welfare-maximizing central bank should adopt flexible headline inflation targeting - i.e. a headline inflation target but with some weight on the output gap. These results are particularly relevant for emerging markets, where the share of food expenditures in total consumption expenditures is high and a large proportion of consumers are credit constrained. In the second chapter, we develop a small open economy model with macrofinancial linkages. The model includes a financial accelerator - entrepreneurs are assumed to partially finance investment using domestic and foreign currency debt - to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks to productivity, interest rates and net worth of firms. We use Bayesian estimation techniques to estimate the model using India data. The model is used to assess the importance of the financial accelerator in India and to assess the optimality of the current monetary policy rule. In the third chapter, we develop a small open economy New Keynesian model with financial frictions and an active banking sector for India. We find that the presence of a monopolistic banking sector with sticky interest rate setting attenuates the shocks. However, if the interest rates are flexible it results in the amplification of shocks. We also find that an unexpected reduction in bank capital can have a substantial impact on the real economy and particularly on investment. Use of nonmonetary policy tools result in greater volatility as compared to when central banks use traditional monetary tightening.

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