A new study in the latest issue of The Journal of Finance assesses the impact of changes in monetary policy on equity prices. The study measures the average reaction of the stock market in order to understand the economic sources of that reaction. The authors found that, on average, a hypothetical unanticipated 25 basis-point cut in the federal funds rate target is associated with roughly a 1 percent increase in broad stock indexes. Of the three possible reasons for this reaction--a decrease in expected future dividends, a rise in the future expected real interest rates used to discount those dividends, or an increase in expected excess returns associated with holding stocks--the impact on excess returns appears to account for the largest share of stock prices' response.
Source: Eurekalert & othersLast reviewed: By John M. Grohol, Psy.D. on 21 Feb 2009
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