The effect of monetary policy on asset prices: evidence from Germany and UK

Abstract

The main objective of this paper is to focus on the effect of monetary policy on asset prices for Germany and UK. Studying this relationship is complicated because asset prices and interest rates are endogenously determined, behave simultaneously and can be affected by other variables. In order to test this relation and solve these problems we use the heteroskedasticity based approach developed by Rigobon and Sack (2004) which focuses the analysis on the shift in the variance of policy shocks that occurs on the days of the monetary authority's meetings. The assumption of a shift in the variance, which we believe to be weaker than the restrictions imposed in the traditional literature, allows to identify the effect of monetary policy on asset prices solving the endogeneity and simultaneity problem. The result we find indicate that German and UK monetary policy do not affect the stock market behaviour. Monetary policy seems to be neutral on the economy. While for Germany we have no significant effect on the exchange rate, an increase of British interest rate appreciates the sterling.