Monetary Policy Shocks and Portfolio Choice

50 Pages Posted: 9 Dec 2009

See all articles by Marcel Fratzscher

Marcel Fratzscher

DIW Berlin; Centre for Economic Policy Research (CEPR)

Christian Saborowski

International Monetary Fund (IMF)

Roland Straub

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: December 9, 2009

Abstract

The paper shows that monetary policy shocks exert a substantial effect on the size and composition of capital flows and the trade balance for the United States, with a 100 basis point easing raising net capital inflows and lowering the trade balance by 1% of GDP, and explaining about 20-25% of their time variation. Monetary policy easing causes positive returns to both equities and bonds. Yet such a monetary policy easing shock also induces a shift in portfolio composition out of equities and into bonds, implying a negative conditional correlation between flows in equities and bonds. Moreover, such shocks induce a negative conditional correlation between equity flows and equity returns, but a positive conditional correlation between bond flows and bond returns. The findings thus provide evidence for the presence of a portfolio rebalancing motive behind investment decisions in equities, but the dominance of what is akin to a return chasing motive for bonds, conditional on monetary policy shocks. The results also shed light on the puzzle of the strongly time-varying equity-bond return correlations found in the literature.

Keywords: monetary policy, trade balance, capital flows, portfolio choice, asset prices, United States, vector auto regressions, sign restrictions

JEL Classification: F4, E52, G1, F32

Suggested Citation

Fratzscher, Marcel and Saborowski, Christian and Straub, Roland, Monetary Policy Shocks and Portfolio Choice (December 9, 2009). ECB Working Paper No. 1122, Available at SSRN: https://ssrn.com/abstract=1513205 or http://dx.doi.org/10.2139/ssrn.1513205

Marcel Fratzscher (Contact Author)

DIW Berlin ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Christian Saborowski

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Roland Straub

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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