Stock returns and monetary policy: Are there any ties?

This paper empirically investigates the following three questions: (i) Do stock returns respond to monetary policy shocks? (ii) Do stock returns alter the transmission mechanism of monetary policy? and (iii) Does monetary policy systematically react to stock returns? Unlike existing empirical research on these topics, we use a structural vector auto-regression that relaxes the restrictions commonly imposed in earlier studies and identify monetary policy shocks by exploiting the conditional heteroskedasticity of the structural innovations. Applying this method to US data, we find that the interaction between monetary policy and stock returns is much weaker than suggested by earlier empirical studies.