Abstract
This paper analyzes how US stock prices respond to monetary policy decisions. On days of FOMC meetings, we decomposed the daily stock market return into cash-flow news, interest rate news, and risk premium news by applying a novel approach which uses information from option prices. The empirical results suggest that the relation between monetary policy surprises and stock returns is state dependent: In expansions (recessions), the cash-flow channel (risk premium channel) explains most of the announcement day returns. However, during time periods with unconventional monetary policy instruments, the risk premium channel has become more important, even in expansions.
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