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MONETARY POLICY INDICATORS AS PREDICTORS OF STOCK RETURNS

Authors


  • The authors thank Scott Beyer, Gerald Gay (the editor), Scott Hein, Nikiforos Laopodis, Philip Lane, Robert Miller, Suchismita Mishra, and participants at the Eastern Finance Association and Financial Management Association for helpful comments.

Abstract

We explore the linkage between stock return predictability and the monetary sector by examining alternative proxies for monetary policy. Using two complementary methods, we document that failure to condition on the Fed's broad policy stance causes a substantial understatement in the ability of monetary policy measures to predict returns. Industry analyses suggest that cross-industry return differences are also linked to changes in monetary conditions, as monetary policy has the strongest (weakest) relation with returns for cyclical (defensive) industries. Overall, we find that monetary conditions have a prominent and systematic relation with future stock returns, even in the presence of business conditions.

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