The Fed and the stock market: A tale of sentiment states

Haifeng Guo, Chi-Hsiou Hung and Alexandros Kontonikas

Journal of International Money and Finance, 2022, vol. 128, issue C

Abstract: We analyze the period before the zero lower bound and show that the state of investor sentiment strongly affects the transmission of monetary policy to the stock market. The impact of Federal funds rate (FFR) surprises is mostly potent when sentiment-driven overvaluation is followed by a correction, whereby the stock market increases by 0.8% in response to an unexpected FFR cut of 10 basis points. Our findings suggest that monetary easing surprises during sentiment-waning phases boost the stock market by alleviating investors’ fear. The ability of sentiment to drive the observed state dependence is hard to reconcile with rational pricing.

Keywords: Investor Sentiment; Monetary Policy Surprises; Event Study (search for similar items in EconPapers)
JEL-codes: E52 G12 G14 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:128:y:2022:i:c:s0261560622001103

DOI: 10.1016/j.jimonfin.2022.102707

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