Stock Prices, Firm Size, and Changes in the Federal Funds Rate Target

FRB St. Louis Working Paper No. 2002-004A

30 Pages Posted: 20 Feb 2002

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Date Written: January 2002

Abstract

The Fed targeted the federal funds rate during the period 1974-79; they returned to that procedure in the late 1980s and have maintained it since then. For both periods, we find that stock prices reacted significantly to unanticipated changes in the federal funds rate target, but not to anticipated ones. Consistent with the prediction of imperfect capital market theories, the estimated impact of monetary shocks decreased with firm size in the late 1970s, when business conditions were typically bad; however, we do not observe such a "size effect" in the 1990s, when business conditions were typically good. Our results thus provide additional support to recent rationales for abnormal returns on value stocks: small stocks on average earn higher risk-adjusted returns than large stocks do because small firms are more vulnerable to liquidity constraints and thus perform worse during economic downturns, but not during expansions.

Keywords: monetary transmission, credit market imperfection, changes in federal funds rate target

JEL Classification: E44, E58, G12

Suggested Citation

Guo, Hui, Stock Prices, Firm Size, and Changes in the Federal Funds Rate Target (January 2002). FRB St. Louis Working Paper No. 2002-004A, Available at SSRN: https://ssrn.com/abstract=300802 or http://dx.doi.org/10.2139/ssrn.300802

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

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