December 2006 issue contents
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.

Full article (PDF, 19 pages 249 kb)

a Federal Reserve Bank of Kansas City
b College of William and Mary