Discussion Paper Details

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Title: Asset Allocation and Monetary Policy: Evidence from the Eurozone

Author(s): Harald Hau and Sandy Lai

Publication Date: August 2013

Keyword(s): asset price inflation, monetary policy, risk seeking and Taylor rule residuals

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: The eurozone has a single short-term nominal interest rate, but monetary policy conditions measured by either real short-term interest rates or Taylor rule residuals varied substantially across countries in the period from 2003-2010. We use this cross-country variation in the (local) tightness of monetary policy to examine its influence on equity and money market flows. In line with a powerful risk-shifting channel, we find that fund investors in countries with decreased real interest rates shift their portfolio investment out of the money market and into the riskier equity market. A ten-basis-point lower real short-term interest rate is associated with a 0.8% incremental money market outflow and a 1% incremental equity market inflow by local investors relative to asset under management. The latter produces the strongest equity price increase in countries where domestic institutional investors represent a large share of the countries' stock market capitalization.

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Bibliographic Reference

Hau, H and Lai, S. 2013. 'Asset Allocation and Monetary Policy: Evidence from the Eurozone'. London, Centre for Economic Policy Research.