Monetary Policy Shocks and Portfolio Choice

Marcel Fratzscher, Roland Straub and Christian Saborowski

No 8099, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Asset prices; Capital flows; Monetary policy; Portfolio choice; Sign restrictions; Trade balance; United states; Vector autoregressions (search for similar items in EconPapers)
JEL-codes: E52 F32 F4 G1 (search for similar items in EconPapers)
Date: 2010-11
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Monetary Policy Shocks and Portfolio Choice (2009)
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