Monetary Policy Shocks and Portfolio Choice

Marcel Fratzscher, Christian Saborowski and Roland Straub

No 1122, Working Paper Series from European Central Bank

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. JEL Classification: F4, E52, G1, F32

Keywords: Asset Prices; capital flows; monetary policy; portfolio choice; sign restrictions.; trade balance; United States; vector auto regressions (search for similar items in EconPapers)
Date: 2009-12
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
Note: 335955
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Working Paper: Monetary Policy Shocks and Portfolio Choice (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20091122

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