Nonlinear relationship between monetary policy and stock returns: Evidence from the U.S

Marcelle Chauvet and Cheng Jiang

Global Finance Journal, 2023, vol. 55, issue C

Abstract: This paper studies the relationship between monetary policy and stock market return in the U.S. using nonlinear econometric models. It first employs a univariate Markov-switching model on each of the three stock indices and three monetary policy variables, displaying significant regime-switching patterns and common movements. This paper then uses a Markov-switching dynamic bi-factor model to simultaneously extract two latent common factors from stock indices and monetary policy variables to represent monetary policy changes and stock market movements separately. The smoothed probabilities of regimes demonstrate that expansionary monetary policy regimes follow economic recessions, but bear stock markets usually occur before economic recessions. The maximum likelihood estimation results show that expansionary monetary policy such as a decrease in the federal funds rate raises stock returns, but stock returns don't directly influence monetary policy decision.

Keywords: Monetary policy; Stock market; Kalman filter; Markov-switching dynamic bi-factor model (search for similar items in EconPapers)
JEL-codes: E44 E52 G11 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:glofin:v:55:y:2023:i:c:s1044028322000989

DOI: 10.1016/j.gfj.2022.100796

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