Monetary policy and stock prices: theory and evidence

The objective of this paper is to evaluate the effects of monetary policy shocks on stock market indices in the G-7 countries and Spain using the methodology of structural VARs. A model is estimated for each country and the effects of monetary policy shocks are evaluated by means of impulse responses. A contractionary shock has a negative and temporary effect on stock market indices. There is evidence of a significant cross-country heterogeneity in the persistence, magnitude and timing of the responses. A limited participation model with households trading in stocks is set up and the responses of stock prices to a monetary policy shock under different rules are evaluated. The model is able to account for the empirical response of stock prices to monetary policy shocks under different policy rules.