Taking stock: monetary policy transmission to equity markets

This paper analyses the effects of US monetary policy on stock markets. We find that, on average, a tightening of 50 basis points reduces returns by about 3%. Moreover, returns react more strongly when no change had been expected, when there is a directional change in the monetary policy stance and during periods of high market uncertainty. We show that individual stocks react in a highly heterogeneous fashion and relate this heterogeneity to financial constraints and Tobin's q. First, we show that there are strong industry-specific effects of US monetary policy. Second, we find that for the individual stocks comprising the S&P500 those with low cashflows, small size, poor credit ratings, low debt to capital ratios, high price-earnings ratios or high Tobin's q are affected significantly more. The use of propensity score matching allows us to distinguish between firmand industry-specific effects, and confirms that both play an important role. JEL Classification: G14, E44, E52credit channel, financial constraints, monetary policy, propensity score matching, S&P500, stock market, Tobin’s q