Monetary policy and stock market valuation

Abstract

This paper estimates the effect of monetary policy on the term structure of stock market risk premia. Stock market risk premia are solved using analysts’ dividend forecasts and dividend future prices. Although risk-free rates have decreased after the global financial crisis, the results indicate that the expected long-term average stock market return has remained quite stable at around 9 percent. This implies that the average stock market risk premium has increased since the financial crisis. The prices of dividend futures suggest that the rise is related to changes in the term structure of risk premia. The effect of monetary policy on risk premia is analysed using VAR models and local projection methods. According to the results, monetary policy easing raises the average risk premium. The effect is driven by a rise in long-horizon risk premia.