Abstract
We uncover a link between U.S. monetary policy and liquidity risk premia in stock markets around the world. Liquidity risk premia vary considerably over time and strongly co-move across countries. They are significantly lower when U.S. monetary policy tightens. A positive shock to the Federal Funds futures rate of 10 basis points is associated with a 41 basis points decline in the liquidity risk premium. This effect is concentrated among high liquidity risk stocks and is more acute when the foreign claims by U.S. banks on the country of interest are unusually high. Overall, our results indicate that U.S. monetary policy shocks affect the pricing of liquidity risk around the world and highlight the importance of a “bank channel” in the transmission of these shocks.
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