Arbeitspapier
Monetary policy and mispricing in stock markets
This paper investigates whether central banks can attenuate excessive mispricing in stocks as suggested by the proponents of a "leaning against the wind" (LATW) monetary policy. For this, we decompose stock prices into a fundamental component, a risk premium, and a mispricing component. We argue that mispricing can arise for two reasons: (i) from false subjective expectations of investors about future fundamentals and equity premia; and (ii) from the inherent indeterminacy in asset pricing in line with rational bubbles. We show that the response of the excessive stock price component to a monetary policy shock is ambiguous in both the short- and long-run, and depends on the nature of the mispricing. Subsequently, we evaluate the scope for a LATW policy empirically by employing a time-varying coefficient VAR with a flexible identification scheme based on impact and long-run restrictions using data for the S&P500 index from 1962Q1 to 2014Q4. We find that a contractionary monetary policy shock in fact lowers stock prices beyond what is implied by the response of their underlying fundamentals.
- Language
-
Englisch
- Bibliographic citation
-
Series: DIW Discussion Papers ; No. 1605
- Classification
-
Wirtschaft
Financial Markets and the Macroeconomy
Monetary Policy
Asset Pricing; Trading Volume; Bond Interest Rates
Information and Market Efficiency; Event Studies; Insider Trading
- Subject
-
asset pricing
bubbles
financial stability
leaning against the wind
mispricing
monetary policy
time-varying coefficient VAR
zero and sign restrictions
- Event
-
Geistige Schöpfung
- (who)
-
Beckers, Benjamin
Bernoth, Kerstin
- Event
-
Veröffentlichung
- (who)
-
Deutsches Institut für Wirtschaftsforschung (DIW)
- (where)
-
Berlin
- (when)
-
2016
- Handle
- Last update
-
10.03.2025, 11:44 AM CET
Data provider
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Beckers, Benjamin
- Bernoth, Kerstin
- Deutsches Institut für Wirtschaftsforschung (DIW)
Time of origin
- 2016
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