Show me the money: the monetary policy risk premium

Ali Ozdagli and Mihail Velikov ()
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Mihail Velikov: https://directory.smeal.psu.edu/mjv5465

No 16-27, Working Papers from Federal Reserve Bank of Boston

Abstract: We study how monetary policy affects the cross-section of expected stock returns. For this purpose, we create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that are theoretically linked to how firms react to monetary policy. We find that stocks whose prices react more positively to expansionary monetary policy surprises earn lower average returns. This finding is consistent with the intuition that monetary policy is expansionary in bad economic times when the marginal value of wealth is high, and thus high MPE stocks serve as a hedge against bad times. A long-short trading strategy designed to exploit this effect achieves an annualized value-weighted return of 9.96 percent with an associated Sharpe Ratio of 0.93 between 1975 and 2015. This return premium cannot be explained by standard factor models and survives a battery of robustness tests.

Keywords: monetary policy; asset pricing; risk factors (search for similar items in EconPapers)
JEL-codes: E12 E31 E44 E52 G12 G14 (search for similar items in EconPapers)
Pages: 67 pages
Date: 2016-12-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Show me the money: The monetary policy risk premium (2020)
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