Show me the money: The monetary policy risk premium

Ali Ozdagli, Mihail Velikov

Research output: Contribution to journalArticle

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 languageEnglish (US)
Pages (from-to)320-339
Number of pages20
JournalJournal of Financial Economics
Volume135
Issue number2
DOIs
StatePublished - Feb 2020

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All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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