State-Dependent Stock Market Reactions to Monetary Policy
by Troy Daviga and Jeffrey R. Gerlachb
This paper presents a test of the response of stock prices to Federal Reserve
policy shocks using a Markov-switching framework. The framework endogenously
identifies two distinct regimes. The first is a state where the S&P 500
index exhibits a significantly negative response to unexpected changes in the
target federal funds rate in the thirty-minute window bracketing FOMC
announcements, a result consistent with previous work. However, the model
identifies a second regime from September 1998 to September 2002, in which the
response of stock prices to policy shocks is insignificant and over ten times
more volatile relative to the other regime.
JEL Codes: E44, G12, G14.
(PDF, 19 pages 249 kb)
a Federal Reserve Bank of Kansas City
b College of William and Mary