Monetary policy surprises, stock returns, and financial and liquidity constraints, in an exchange rate monetary policy system

• Published in: The Quarterly review of economics and finance 2021-08, Vol.81, p.226-236
• Main Author: Sequeira, John M.
• Format: Article
• Language: English
• Subjects: Financial constraints; Liquidity constraint; Monetary policy; Sector classification
• ISSN: 1062-9769; 1878-4259
• DOI: 10.1016/j.qref.2021.06.005

•We examine the impact of monetary policy surprises on the stock market of a small developed economy, whose monetary policy is based on the exchange rate.•The findings provide potentially useful information for the central bank, as it allows them to consider the effect of specific policy actions on stock market performance that could be used to better inform on the overall impact of monetary policy.•We also find that financial and liquidity constraints help to explain the sector responses to monetary policy surprises. This study examines the impact of monetary policy surprises on the stock price behaviour of a small developed economy, whose monetary policy is based on the exchange rate. We find that monetary policy surprises associated with all contractionary policy levers and a neutral policy lever, have a consistently significant and negative impact on stock returns. In comparison, only monetary policy surprises associated with a downward re-centering policy lever, has a significantly positive effect on stock returns. Using a recalibrated classification system, we also find that monetary policy surprises differ across sectors of the economy. Our results show how monetary policy surprises can have a significant impact on the stock market by having a disproportionate effect on sectors that face financial and liquidity constraints.