Monetary policy surprises and the cross sectional stock return predictability in volume sorted portfolios

Abstract

The predictive power of monetary policy for the aggregate stock market has been well documented. This paper provides the first empirical evidence on whether monetary policy also predicts/explains any existing return anomalies (cross sectional return predictability) that figure prominently in the asset price literature. The results show that the Fed's forward guidance helps predict the volume premium, a notion that stocks that recently receive a substantial positive volume shock earn higher average returns. In contrast, current monetary policy action does not predict the return anomaly. Furthermore, the predictive power of monetary policy adopted after the unscheduled FOMC meetings is twice as strong as that following the scheduled meetings. Nevertheless, the predictive relation is statistically insignificant in the zero-lower-bound (ZLB) period.