Show me the money: The monetary policy risk premium

Ali Ozdagli; Mihail Velikov

doi:10.1016/j.jfineco.2019.06.012

Show me the money: The monetary policy risk premium

Ali Ozdagli, Mihail Velikov

Finance

Research output: Contribution to journal › Article › peer-review

21 Scopus citations

Abstract

We create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that previous studies link to how stocks react to monetary policy. Our index successfully captures stocks’ responses to both conventional and unconventional monetary policy. Stocks whose prices react more positively to expansionary monetary policy (high-MPE stocks) earn lower average returns. This result is consistent with the notion that high-MPE stocks provide a hedge against bad economic shocks, to which the Federal Reserve responds with expansionary monetary policy. A long-short trading strategy designed to exploit this effect achieves an annualized Sharpe Ratio of 0.77.

Original language	English (US)
Pages (from-to)	320-339
Number of pages	20
Journal	Journal of Financial Economics
Volume	135
Issue number	2
DOIs	https://doi.org/10.1016/j.jfineco.2019.06.012
State	Published - Feb 2020

All Science Journal Classification (ASJC) codes

Accounting
Finance
Economics and Econometrics
Strategy and Management

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10.1016/j.jfineco.2019.06.012

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title = "Show me the money: The monetary policy risk premium",

abstract = "We create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that previous studies link to how stocks react to monetary policy. Our index successfully captures stocks{\textquoteright} responses to both conventional and unconventional monetary policy. Stocks whose prices react more positively to expansionary monetary policy (high-MPE stocks) earn lower average returns. This result is consistent with the notion that high-MPE stocks provide a hedge against bad economic shocks, to which the Federal Reserve responds with expansionary monetary policy. A long-short trading strategy designed to exploit this effect achieves an annualized Sharpe Ratio of 0.77.",

author = "Ali Ozdagli and Mihail Velikov",

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AB - We create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that previous studies link to how stocks react to monetary policy. Our index successfully captures stocks’ responses to both conventional and unconventional monetary policy. Stocks whose prices react more positively to expansionary monetary policy (high-MPE stocks) earn lower average returns. This result is consistent with the notion that high-MPE stocks provide a hedge against bad economic shocks, to which the Federal Reserve responds with expansionary monetary policy. A long-short trading strategy designed to exploit this effect achieves an annualized Sharpe Ratio of 0.77.

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Show me the money: The monetary policy risk premium

Abstract

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