Monetary Policy Shocks and Stock Returns : Identification Through Impossible Trinity

This paper aims to identify the effect of monetary policy shocks on stock prices through the lens of Mundell and Fleming's “Impossible Trinity” theory. Our identification strategy seeks to solve the simultaneity and omitted variable problems inherent in studies that focus on the effect of monetary policy on asset prices. Moreover, we use our identification strategy to test the hypothesis that stock prices of financially constrained firms are more responsive to monetary policy shocks. Our results so far do not support this hypothesis, which seems to contradict the financial accelerator theory presented in Bernanke, Gertler, and Gilchrist (1999) but is consistent with Lamont, Polk, and Sa´a-Requejo (2001) who find that the relative stock market performance of constrained firms does not reflect monetary policy or credit conditions