The Fed and the Stock Market: A Tale of Sentiment States

Guo, Haifeng; Hung, Chi-Hsiou D.; Kontonikas, Alexandros

Abstract

We analyze the period before the zero lower bound and show that the state of investor sentiment strongly affects the transmission of monetary policy to the stock market. The impact of Federal funds rate (FFR) surprises is mostly potent when sentiment-driven overvaluation is followed by a correction, whereby the stock market increases by 0.8% in response to an unexpected FFR cut of 10 basis points. Our findings suggest that monetary easing surprises during sentiment-waning phases boost the stock market by alleviating investors’ fear. The ability of sentiment to drive the observed state dependence is hard to reconcile with rational pricing.

Citation

Guo, H., Hung, C. D., & Kontonikas, A. (2022). The Fed and the Stock Market: A Tale of Sentiment States. Journal of International Money and Finance, 128, Article 102707. https://doi.org/10.1016/j.jimonfin.2022.102707

• Journal Article Type: Article
• Acceptance Date: Jul 6, 2022
• Online Publication Date: Jul 9, 2022
• Publication Date: 2022-11
• Deposit Date: Jul 13, 2022
• Publicly Available Date: Aug 1, 2022
• Journal: Journal of International Money and Finance
• Print ISSN: 0261-5606
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 128
• Article Number: 102707
• DOI: https://doi.org/10.1016/j.jimonfin.2022.102707
• Public URL: https://durham-repository.worktribe.com/output/1197731