The Transatlantic Transmission of Monetary Policy Shocks

Edoardo Pricolo & Simon Hepp

Student thesis: Master thesis

Abstract

This paper examines how U.S. and European equity markets react to unanticipated changes in monetary policy initiated by the Federal Reserve System and the European Central Bank. We find that, on average, both U.S. and European equity markets rise in response to negative Fed shocks. However, for ECB shocks, the coefficients are of the opposite sign, as both U.S. and European equity markets fall. Standard logic indicates that transatlantic heterogeneity in the response of equity markets to shocks is due to heterogeneity in the wealth-substitution effect trade-off. The wealth effect dominates the substitution effect for the ECB shocks, while the opposite holds for Fed shocks. Furthermore, the study finds that the reaction to the different shocks varies in terms of timing. Around Fed meetings, stock markets start to react already the day before the announcement of the new monetary policy, while the reaction of markets to ECB shocks occurs solely after the publication of the central bank’s decision. Finally, for all shocks and equity markets, we present evidence of sticky price responses to surprises.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2016
Number of pages80
SupervisorsPaul Whelan