Monetary policy, investor sentiment and stock returns

Guo, Haifeng (2019) Monetary policy, investor sentiment and stock returns. PhD thesis, University of Glasgow.

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Abstract

This doctoral thesis empirically investigates the response of the U.S. market-wide and cross- sectional stock returns to monetary policy shocks after the Federal Open Market Committee (FOMC) meetings, across different sentiment states between June-89 to October-14. It also examines the impact of investor sentiment states on the market-wide stock price drift before the scheduled FOMC announcements.
Chapter 1 demonstrates that the state of investor sentiment strongly affects the transmission of conventional and non-conventional monetary policy to the stock market. In particular, monetary policy shocks significantly affect market-wide stock returns only during sentiment- correction periods. In contrast, during periods of optimism build-up, the stock market response is statistically insignificant. The sentiment-based state dependence in the response of stock market returns to monetary policy shocks sheds important light on a sentiment channel in the monetary policy transmission mechanism.
We extend our empirical analysis to cross-sectional stock returns in Chapter 2. Our estimates show that monetary policy shocks significantly affect cross-sectional stock returns only during sentiment-correction periods. We construct a long-short strategy, according to which we define the stocks which are more exposed to investor sentiment as the short leg. Our results show that monetary policy shocks positively drive the long-short spread, with a larger impact on the short leg stocks. Specially, Federal Funds Rate (FFR) surprises have larger impacts on the stocks with high accruals, young stocks, stocks with high asset growth rate, stocks with low book-to-market ratio, stocks with high cash to asset ratio, stocks with low gross profitability, high investment stocks, past loser stocks, stocks with high net operating assets, stocks with low asset tangibility, less profitable stocks, stocks with high return volatility, and large stocks before the zero lower bound (ZLB) was reached. The long-short strategy is reconstructed after the ZLB was reached due to changes in stocks’ sensitivity to investor sentiment. However, it is still the short leg stocks that are more affected by the path surprises. The stronger response of the short leg implies that the stocks which are more exposed to investor sentiment are also more sensitive to monetary policy shocks.
Finally in Chapter 3 we examine how investor sentiment states affect the stock price drift before the scheduled FOMC announcements. We find that the returns on the S&P500 index increase significantly over the pre-FOMC window only during periods of high sentiment. We also find that investors allocate assets from low risk short-term T-bills to stocks on the pre- FOMC window during periods of high sentiment. Our findings on the pre-FOMC announcement order imbalance show that there are more buyer-initiated trade than seller-initiated trade on the S&P500 constituents during periods of high sentiment. These findings provide a behavioural explanation to the pre-FOMC announcement puzzle.

Item Type: Thesis (PhD)
Qualification Level: Doctoral
Keywords: Monetary policy, investor sentiment, stock return.
Subjects: H Social Sciences > HG Finance
Colleges/Schools: College of Social Sciences > Adam Smith Business School > Accounting and Finance
Supervisor's Name: Hung, Dr. Chi-Hsiou and Kontonikas, Professor Alexandros
Date of Award: 2019
Depositing User: Mr Haifeng Guo
Unique ID: glathesis:2019-72465
Copyright: Copyright of this thesis is held by the author.
Date Deposited: 05 Jun 2019 14:58
Last Modified: 05 Jun 2019 15:01
URI: http://theses.gla.ac.uk/id/eprint/72465

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