The Reactions of Equity and Credit Markets to Unconventional Monetary Policy - Are the Markets Buying It?

Abstract

The reaction of asset markets to the announcement of monetary policy measures is regarded as crucial for the transmission mechanism of monetary policy. I test whether the cross-sections of European equities and CDS show responses to monetary shocks which are in accordance with the goals behind the ECB policies. In particular, I assess whether credit constrained firms show stronger reactions than firms which are unlikely to be credit constrained. The balance sheet channel of monetary policy states that unconventional monetary policy lifts credit constraints. I obtain some unsettling results: Market reactions to conventional short rate changes are completely at odds with economic theory, but reactions to unconventional measures are in line with theory. Moreover, the reactions in the cross-section contradict the story of the balance sheet channel.