Monetary policy expectation errors

Maik Schmeling, Andreas Schrimpf and Sigurd A.M. Steffensen

Journal of Financial Economics, 2022, vol. 146, issue 3, 841-858

Abstract: How are financial markets pricing the monetary policy outlook? We use surveys to decompose excess returns on money market instruments into expectation errors and term premia. Excess returns are primarily driven by expectation errors, whereas term premia are negligible. Investors face challenges when learning about the Federal Reserve’s response to large, but infrequent, negative shocks in real-time. Rather than reflecting risk compensation, excess returns stem from investors underestimating how much the central bank eases policy in response to such rare shocks. We show, for the US and internationally, that expectation errors imply excess return predictability from past stock returns.

Keywords: Expectation formation; Monetary policy; Federal funds futures; Overnight index swaps; Uncertainty (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 G15 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:146:y:2022:i:3:p:841-858

DOI: 10.1016/j.jfineco.2022.09.005

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