Stock market effects of unconventional monetary policy

Abstract

While the existing academic literature has demonstrated the positive effects of unconventional monetary policy on the real economy and financial markets, its primary focus has been on the early post-global financial crisis period. This thesis aims to contribute to the literature by using more recent data sample from 2004 to 2021, including also the COVID-19 period. In this thesis, I examine the effects of unconventional monetary policy on stock market valuations and the real economy. To account for the dynamic relationship between rare disaster risk and unconventional monetary policy, an important factor highlighted in previous literature, I incorporate rare disaster risk proxied by implied volatility into the analysis. I use the structural VAR model with sign restrictions to uncover the dynamic causal relationships between the variables.

The results indicate that an exogenous unconventional monetary policy shock has a positive and persistent effect on stock market valuations in the euro area and in the US, as well as a positive and persistent effect on the ex-ante growth rate in the euro area and a positive and transient effect in the US. Furthermore, an exogenous implied volatility shock leads to a negative and persistent effect on stock market valuation and ex-ante growth in both regions. Importantly, the findings suggest that the central banks should refrain from adjusting their monetary policy in response to a negative shock to stock market valuations.