Essays on Monetary Policy and Financial Markets

Abstract

This dissertation investigates how U.S. monetary policy actions—and the uncertainty that surrounds them—shape equity-market behavior at home and abroad. Across three self-contained essays, I employ high-frequency surprise measures and news-based uncertainty indices to document heterogeneous responses that vary by risk factor, industry, and country.

The first essay, "The Impact of Monetary Policy Surprises on Equity Risk Factors and Market Sectors," investigates the heterogeneous responses within the U.S. equity market. Utilizing high-frequency monetary policy surprises derived from interest rate futures around FOMC announcements, this study regresses daily returns of Fama-French equity risk factors (Market, Size, Value, Profitability, Investment, augmented with Momentum, Short-Term Reversal, and Long-Term Reversal) and detailed industry portfolios on these surprises. Key findings indicate a significant negative market-wide response to tightening surprises. Notably, style factors exhibit varied sensitivities: Size (SMB), Investment (CMA), Momentum (MOM), and Long-Term Reversal (LTR) show positive responses to tightening, while Short-Term Reversal (STR) reacts negatively. Value (HML) and Profitability (RMW) show insignificant immediate responses. Cyclical and discretionary industry sectors demonstrate pronounced negative reactions, whereas defensive sectors exhibit more muted impacts, underscoring the differential transmission of policy shocks across the U.S. equity landscape.

The second essay, "The Heterogeneous Impact of Monetary Policy Uncertainty on Equity Market Sectors," examines how uncertainty surrounding U.S. monetary policy affects various U.S. equity sectors. Employing the Husted-Rogers-Sun (2020) news-based Monetary Policy Uncertainty (MPU) index, this essay uses OLS regressions to analyze the contemporaneous relationship between monthly MPU changes and the excess returns of the Fama-French 12 industry portfolios. The results consistently reveal a negative association between MPU and sectoral returns, with statistically significant adverse impacts observed for Non-Durables, Manufacturing, Chemicals, Telecommunications, Retail & Wholesale, and Health sectors. Financials and a miscellaneous "Other" category show weakly significant negative effects. While MPU demonstrates a pervasive negative influence, its explanatory power for monthly return variations is modest, suggesting it acts as a secondary or episodic driver.

The third essay, "The Transmission of Monetary Policy Surprises to International Equity Markets," extends the analysis of U.S. monetary policy surprises to the global stage. Using the Bauer-Swanson (2023) high-frequency surprise dataset, this study assesses the spillover effects on equity markets in developed economies, emerging markets, and countries with fixed exchange rate regimes. The findings highlight significant heterogeneity: key emerging markets, particularly Brazil and Mexico, exhibit strong and statistically significant negative sensitivities to U.S. tightening surprises. In contrast, responses in most developed markets are generally subdued and statistically insignificant. Markets with fixed exchange rates to the USD, notably Dubai (UAE), can even display significant positive reactions, suggesting complex interactions between U.S. policy, local economic structures (such as commodity dependence), and regional financial dynamics.

Collectively, these essays contribute to a deeper understanding of how monetary policy actions and the uncertainty surrounding them differentially affect various segments of domestic and international equity markets. The findings offer implications for investment strategy, risk management, and the formulation of monetary policy in an interconnected global financial system.