State-Dependent Stock Market Reactions to Monetary Policy: 'Bubble' vs. Fundamental States

22 Pages Posted: 20 Feb 2006

See all articles by Troy Davig

Troy Davig

Federal Reserve Bank of Kansas City

Jeffrey Gerlach

College of William and Mary - Department of Economics

Date Written: May 5, 2006

Abstract

This paper presents a test of the response of stock prices to Federal Reserve policy shocks using a Markov-switching framework. The framework endogenously identifies two distinct regimes. The first is a state where the S&P 500 index exhibits a significantly negative response to unexpected changes in the federal funds target in the thirty minute window bracketing FOMC announcements, a result consistent with previous work. However, the model identifies a second regime from September 1998 to September 2002, where the response of stock prices to policy shocks is insignificant and more volatile relative to the other regime.

Keywords: Monetary Policy, Stock Market, Markov Switching

JEL Classification: E44, G14

Suggested Citation

Davig, Troy and Gerlach, Jeffrey, State-Dependent Stock Market Reactions to Monetary Policy: 'Bubble' vs. Fundamental States (May 5, 2006). Available at SSRN: https://ssrn.com/abstract=882151 or http://dx.doi.org/10.2139/ssrn.882151

Troy Davig (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Jeffrey Gerlach

College of William and Mary - Department of Economics ( email )

Williamsburg, VA 23187-8795
United States

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