Essays in Monetary Policy and Financial Markets
- Author(s): Bilyi, Mykyta
- Advisor(s): Sraer, David
- et al.
One of the ultimate goals of financial economics is to understand the mechanisms that drive asset prices, both on the macroeconomic level, and on the more granular level that involves interactions between groups of investors. In my dissertation, I study the settings in which monetary policy announcements act as a source of exogenous shocks. The heterogeneous cross-sectional response of asset prices to such shocks could be used to understand the channels through which the policy affects the market, and also to study the effects of market frictions on prices.
In the first chapter, I focus on the movements of the stock prices in anticipation of monetary policy announcements. Lucca and Moench (2015) document a significant upward drift in the stock market in the 24 hours preceding meetings of the Federal Open Market Committee (FOMC). This drift is not conditional on realized monetary policy shocks. My first chapter offers an explanation for this finding that is based on disagreement and short-selling constraints. When investors hold heterogeneous beliefs about the content of the upcoming monetary policy announcement and for some market participants it is costly or impossible to short-sell, speculative demand from optimistic investors can drive up prices before the announcement. This can be especially the case for stocks that are more sensitive to the monetary policy shocks, more expensive to short-sell, and during periods of high disagreement about the FOMC decisions. I confirm this intuition in a series of empirical tests using the cross-section of U.S. equities.
In the second chapter, my coauthor Christian Jauregui and I seek to understand what could monetary policy shocks tell us about optimal bank capital requirements. We find news following U.S. FOMC announcements can be viewed as quasi-natural "stress-tests" impacting U.S. banks depending on their equity capital ratios. The heterogeneous response of banks' equity returns and bond yields to surprises in interest rates reveal how financial markets favorably value excess equity capital. We show the equity return of a bank in the 75th percentile of total equity capital ratio is roughly 1/6 less sensitive to monetary policy shocks than a bank in the 25th percentile. Similarly, corporate bond yields of banks with larger equity capital ratios are better insulated against unexpected changes in the "slope", or rate of change, of monetary policy. We conclude that higher capital requirements are viewed positively by market participants.