State Dependency of Bank Stock Reaction to Federal Funds Rate Target Changes

Abstract

We investigate the effects of changes in the federal funds target rate on bank stock returns through an event-study analysis. We examine the state dependency of such effects and focus on the surprise elements of policy changes derived from the federal funds futures market. Although we confirm an inverse relation between bank stock returns and changes in the federal funds target rate previously supported in the literature, we find that bank stock returns only respond to surprise or unexpected changes in the federal funds target rate. We also find that such responses are conditional on the context in which policy changes take place. Copyright (c) 2010 The Southern Finance Association and the Southwestern Finance Association.

The Sensitivity of Non-U.S. Bank Stock Returns to Changes of U.S. Monetary Policy

“…Column (3) of Table 6 provides strong evidence that U.S. monetary policy reversal elicits a larger effect on non-U.S. banks than a target change that extends the previous monetary policy direction. This is consistent with the existing literature for U.S. bond market (Thornton, 1998), the general U.S. stock market (Bernankee and Kuttner, 2005), and U.S. bank stocks (Yin, Yang and Handorf, 2010). The positive and significant coefficient in Column (4) of Table 6 shows that non-U.S. banks are less responsive to positive than to negative federal funds rate target changes.…”

“…The coefficient for the capital regulation factor is positive and statistically significant as shown in Column (4) of Table 8, indicating that more stringent capital requirement in a country makes the bank stock returns less responsive to U.S. monetary shocks. This result remains positive but less significant when all countrylevel variables are included in the regression, as shown in Column (7). This finding confirms our results in Columns ( 4) and ( 6) of Table 7, where banks with higher capital ratios are less susceptible to U.S. monetary shocks, but the statistical significance vanishes when other bank characteristics variables are controlled for.…”

“…During the sample period, there are 53 changes in the federal funds rate target and 65 FOMC meetings in which the Fed decided not to change the target rate. The data for the target changes and FOMC meetings are compiled from the website of Federal Reserve Bank of New York, transcripts of FOMC meetings and the website of Federal Reserve Board of Governors 7. Among the 53 changes in the federal funds rate target, there are 10 target cuts at 50 basis points, 12 cuts at 25 basis points, 26 target increases at 25 basis points, 4 increases at 50 basis points and 1 increase at 75 basis points.…”

Bank characteristics and stock reactions to federal funds rate target changes

“…They find a strong inverse relationship between the Fed interest rate changes (the federal funds rate and the discount rate) and bank stock returns. Using a different data set that covers 1988-2007, Yin et al (2010 confirm the inverse relationship between bank stock returns and federal funds rate target changes. More importantly, they find that bank stock returns only respond to surprise changes in the federal funds rate target.…”

Interbank Network Characteristics, Monetary Policy ‘News’ and Sensitivity of Bank Stock Returns

“…Such policies, which aim to support economic recovery, not only have an influence on liquidity and credit conditions of FIs, but also on equity markets. The reaction of bank stock returns to monetary policy announcements provides information on the impact of monetary policies on bank performance and more generally on their effectiveness in regulating the economy (Yin et al, 2010). The conventional and unconventional monetary policies affect the investment decisions of stock traders by shifting market expectations on future central bank policy rates and other effective macroeconomic indicators.…”