The Reaction of Stock Prices to Unanticipated Changes in Money: A Note

Abstract

MUCH OF THE PAST work on the money-stock market relationship centered on the question of whether money is a leading indicator of stock prices. Studies by Sprinkel [22], Homa and Jaffee [10], and Hamburger and Kochin [8] supported the view that past increases in money lead to increases in equity prices. The implication of this work was that investors could earn above normal proflts by using a trading strategy based on the observed behavior of the money stock. This contradicts the efficient markets hypothesis which asserts that current asset prices reflect all available information so that no such trading strategy can exist. Subsequent research by Cooper [3], Pesando [17], Rozeff [21], and Rogalski and Vinso [19] has shown that past money changes do not contain predictive information on stock prices, upholding the efficient markets view. This paper investigates whether the response of common stock prices to weekly money announcements is consistent with the efflcient markets hypothesis. Unlike the above research, therefore, the focus is on the very short-run response of stock prices to both anticipated and unanticipated announced changes in money. Recent work by Berkman [1], Grossman [7], Urich and Wachtel [25], and Roley [20] indicates that short-term interest rates respond only to the unexpected component of the announcement, with short-term rates rising when the announced change in money exceeds the expected change.' Berkman also examined the reaction of stock prices, finding that an unanticipated increase in the money supply depressed share prices. Lynge [13] found that positive money announcements lowered stock prices, but since he did not distinguish expected from unexpected money growth, his results do not bear directly on the efficient markets issue. In investigating the response of stock prices to weekly money announcements, survey data on market participants' forecasts of the announced weekly change